Parliament panel: too difficult for regulators to enforce ban on proprietary trading

Confirming what your humble blogger has been saying about the Volcker Rule, the Parliament Commission on Banking Standards said it would be too difficult for regulators to enforce a ban on proprietary trading.

According to a Reuters article, the Commission proposed a series of one off solutions like raising capital requirements to limit proprietary trading.

Regular readers know that the direct way to effectively ban proprietary trading by banks is to require them to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this disclosure, market participants will be able to see what "trading positions" the banks have.

Then, as Paul Volcker would say, the market knows a proprietary trade when it see it.

For banks, disclosure of proprietary trading changes the economics of engaging in proprietary trading.  When the market "sees" a proprietary trade, it will trade against the banks in such a way as to minimize the profit of the trade and maximize the downside of the trade.

At the same time, investors who provide funds to the bank will raise their required return for providing funds.  After all, the bank that engages in proprietary trading has higher risk.

With lower profitability from any individual trade and lower profitability from its higher risk profile, bankers have an incentive to exit the proprietary trading business.

A U.S.-style ban on Britain's banks trading with their own money is not needed and would be too difficult to enforce, a group of influential lawmakers said on Friday. 

Instead, Britain should use the threat of capital add-ons or other tools to bear down on any bank that shows signs of proprietary trading, said the Parliamentary Commission on Banking Standards (PCBS). 

The PCBS said a U.S. ban on proprietary trading, known as the Volcker rule, has shown it is difficult to define and prohibit such trading, and it would impose an extra burden on UK regulators who already have to enforce a complex separation of banks' retail operations. 

"The Banking Commission does not feel it appropriate to recommend the immediate prohibition of proprietary trading," said Andrew Tyrie, chairman of the PCBS. 

But he did not rule out a ban in the future. 

"Were this approach to prove ineffective, further measures, including prohibition, could be desirable," he said in report released by the PCBS....

UK banks told the PCBS they do not engage in proprietary trading and said they do not want to, but Tyrie said that could change: "At a time when banks are under less intense scrutiny, proprietary trading could re-emerge as a greater risk." 

He said proprietary trading was not a suitable activity for a bank, and could lead to conflicts of interest, have harmful cultural effects and raise pay expectations. 

The Prudential Regulation Authority, which takes over UK financial regulation in April, should pay close attention to big trading units and volatile revenue flows, and if it spots potential proprietary trading it should use capital add-ons or other methods to incentivise the firm to exercise tighter control, Tyrie said.