One week after Barack Obama announced broad new measures to ban deposit-taking banks from proprietary trading, the so-called Volker rule continues to provoke angst in Wall Street and the City as banks and market participants try to establish the impact this ban will have on earnings at investment banks.
While estimates vary from a 1-2 per cent cut in earnings, predicted at JP Morgan and Bank of America, to about 10 per cent at Goldman Sachs, another issue that has emerged is the definition of prop-trading itself. We can really only assess the impact that US proposals will have on banks, once we see the draft legislation and know whether market-making is included in the prop trading category.
Separating pure prop-trading from legitimate prop-trading or market making (carried out in connection to client mandates) will be difficult. One possible outcome is that large universal banks will start looking to separate their prop-trading and market-making activities from the main bank. The bank would become a part-owner of the separated unit probably in conjunction with an MBO by the staff. This has happened before in the 80s and 90s.
It is, however, too early to calculate the impact of the US proposal on bank revenues, until there is a concrete draft legislation text. What is certain though, whatever the impact on individual banks, is that any measures to restrict market activity will shrink the existing trading volumes and reduce liquidity in the markets. The impact that this will have on the efficiency and price accuracy in the markets is one number that policymakers should be interested in.