Banks as Regulated Traders

Banks use trading as a vehicle to take risk. Using unique high-frequency regulatory data, we estimate the sensitivity of weekly bank trading profits to aggregate equity, fixed-income, credit, currency and commodity risk factors. Our estimates imply that U.S. banks had large trading exposures to equity market risk before the Volcker Rule, which they curtailed afterwards. They also have exposures to credit and currency risk. The results hold up in a quasi-natural experimental design that exploits the phased-in introduction of reporting requirements to address identification. Heterogeneity and placebo tests further corroborate the results. Counterfactual stress-test analyses quantify the financial stability implications.

The Economic Analysis of Volcker Rule

This paper aims to analyze the final regulations of the Volcker Rule in order to assess any lingering concerns related to the administration of the Rule. Despite the problems criticized by many practitioner and scholars, implementing the Volcker Rule has benefits for banks and the overall economy. First, prohibiting proprietary trading activities may make individual institutions and the banking system as a whole safer. Second, the prohibition on banks’ ownership interest in private equity and hedge funds directly addresses a source of bank default risk – the Volcker Rule limits banks’ exposure to risky private equity and venture capital activities, which are activities that contributed to banks’ probability of default during the 2008 financial crisis. Third, heightened compliance standards and documentation requirements will help improve transparency of banking activities and contribute to bank stability.

Venture Capitalists' Access to Finance and Its Impact on Startups

Although an extensive literature shows that startups are financially constrained and that constraints vary by geography, the source of these constraints is still relatively unknown. We explore intermediary financing constraints, a channel studied in the banking literature, but only implicitly addressed in the venture capital (VC) literature. Our empirical setting is the VC fundraising and startup financing environment around the passage of the Volcker Rule, which restricted banks' ability to invest in venture capital funds as limited partners (LPs). The rule change disproportionately impacted regions of the U.S. historically lacking in VC financing. We find that a one standard deviation increase in VCs' exposure to the loss of banks as LPs led to an 18% decline in fund size and about a 10% decrease in the likelihood of raising a follow-on fund. Startups were not completely cushioned from the additional constraints on their VCs: capital raised fell and pre-money valuations declined. Overall, VC financing constraints manifest as fewer, smaller funds that change investment strategy and ex- perience increases in bargaining power. Last, we show that the rule change increased the likelihood startups moved out of impacted states, thus exacerbating the geographic disparity in high-growth entrepreneurship.

Volcker Rule in Practice

Established as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Volcker Rule’s restriction of banks and financial companies from participating in proprietary trading was conceived of as a response to the systemic institutional failures that are commonly noted to be partially responsible for the financial crisis of 2008. Over its short and contentious lifetime, the Rule has been widely praised by some as a necessary step toward limiting unsustainably risky corporate investment practices, and widely vilified by others as being poorly drafted, impracticably restrictive, and only tenuously connected to the crisis precipitating its enactment. The conspicuous disunity among participants in this discussion reflects, in part, the difficulty of measuring the direct impact that the Volcker Rule has had since its enactment, particularly given the complexity of the investment activities the Rule attempts to regulate and the dearth of conclusive statistics indicating which phenomena are accurately attributable to the Rule’s interference. Through a survey and analysis of the public’s input and assessment of the Volcker Rule and its more recent development, this Note explores how administrative processes have fared in giving an adequate voice to the various viewpoints of affected private citizens, businesses, and public entities. Ultimately, this Note argues that the Volcker Rule’s surprisingly modest evolution to date is overshadowed by charged rhetoric, vast information gaps, and unbalanced regulatory feedback rather than substantive bilateral exchange—a phenomenon frustratingly typical of the democratic processes in the context of complex financial reform. This Note concludes by offering reflections on the Volcker Rule’s evolution to date and what the data examined has to say about the successes and shortcomings of the lawmaking processes driving that evolution forward.

Dodd-Frank and the Regulation of Depository Institutions Capital Requirements

This chapter continues the discussion of the previous chapter on the Dodd-Frank Act. In the years since its passage, the legislation has had dramatic effects on the operation and stability of the financial markets, and will continue to play a vital role in the capital markets. In addition to establishing new capital and leverage requirements for banks, bank holding companies, and systemically significant nonbanks, Dodd-Frank also mandates that these requirements be “countercyclical, so that the amount of capital required to be maintained by a company increases in times of economic expansion and decreases in times of economic contraction.” The remainder of the chapter covers the Volcker Rule; living wills, credit exposure reports, and concentration limits; and other prudential standards.