What is the Volcker Rule?

Running a business invariably requires a little borrowing from time to time. Whenever you need anything from startup capital to a bridging loan, or just a little something to ease cash flow, you need to deal with banks to obtain funding. But the activities of the banks you use could impact your business in unforeseen ways, as the financial crash of 2007-2008 proved. The crisis hit small and midsize businesses hard. And many SMBs, whether they know it or not, are still feeling the effects of that event more than a decade on. 

The Volcker rule might have a dystopian sci-fi ring to it, but it’s actually a piece of legislation that can help protect vulnerable SMBs and prevent them from being damaged in the same way as they were 12-13 years ago. However, the Volcker rule is not without its critics. Let’s take a closer look.

The Volcker rule in context

To better understand the effects of the Volcker rule on businesses, it’s important to look at the historic and economic context. As a result of the economic depression in 2007-20 08 and the loss of marginal propensity to consume, many businesses lost customers and were forced to lay off employees or shutter their doors altogether. Between 2008 and 2010, around 1.8 million SMBs went under. As the banks struggled to course correct, lending conditions became extremely prohibitive, with many promising startups no longer able to access funding. 

Almost overnight it became virtually unheard of for larger banks to lend to small businesses and even smaller banks dramatically reduced the number of commercial loans they gave out.

The Volcker rule is intended to prevent the reckless, speculative and often wholly self-serving investment that gave rise to the crisis. It prevents banks from conducting dangerous or suspicious investment activities with their own accounts, while also limiting relationships with hedge funds and private equity funds. 

Who is the Volcker rule named after?

The Volcker rule is named after former chairman of the federal reserve, Paul Volcker. E proposed the legislation in direct reaction to the financial crisis. After the Clinton administration partially repealed the Glass-Steagall Act in 1999, commercial banks were free to trade in the same commodities as investment banks, thereby inflating their profit margins. The results proved disastrous for the national and global economies.

The Volcker rule was intended to undo this damage.

How was the Volcker rule implemented?

The Volcker rule was passed in 2010, and developed a specific set of regulations developed and overseen by five agencies. These are:

• The Federal Reserve

• The Commodities Futures Trading Commission

• The Federal Deposit and Insurance Corporation

• The Office of the Comptroller of the Currency 

• The Securities and Exchange Commission

What is the current status of the Volcker rule?

In June 2020 the final modification was made to the Volcker rule. It eliminated non-risky practices that had previously been banned by the Volcker rule, as well as limiting the impact of the Volcker rule on banks’ activities overseas, and clarifying prohibitions against banks from using private equity and hedge funds.

Criticisms of the Volcker rule

Although the Volcker rule can go a long way to protect businesses and individuals, some critics claim that the rule will reduce liquidity for banks, while others say it will be very difficult and costly to enforce, with costs associated with the rule outweighing the prospective benefits. 

What does the Volcker rule mean for your business?

Despite the valid criticisms of the Volcker rule, your business can benefit from it in a number of ways. For instance:

• There’s less likely to be another financial crisis that massively prohibits commercial borrowing

• Your deposits are safer because banks can’t use them for risky investments

• Smaller lenders are less likely to be bought out by big banks. This makes for a more competitive commercial finance market and better choice of rates

We can help

If you’re interested in finding out more about the Volcker rule, and how it may affect your business and its finances then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.