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Citigroup: How Will The Volcker Rule Impact Profits?

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The Dodd - Frank Wall Street Reform and Consumer Protection Act was written to “create a sound economic foundation to grow jobs, protect consumers, reign in Wall Street and big bonuses, end bailouts and too big to fail, (and) prevent another crisis.” It is the Dodd – Frank legislation that brought down debit card fees, costing banks mightily in their non-interest income. That one step has been estimated to have cost banks as much as $8 billion in revenue. The next round of regulation to take place may be the so called “Volcker Rule”, which is supposed to go into effect this July. I am going to look at how the Volcker Rule has impacted, or will impact, some of the nation's largest banks.

It is important to note that it seems more likely than not that the Volcker Rule will never go into effect, due no doubt to the 2000 bank employed lobbyists who have fought it.


The gist of the Volcker Rule is to greatly limit large banks' ability to make proprietary trades on their own behalf. The lobbyist led charge against the rule has resulted in an over 500 page document with language only a New York lawyer would like. As an aside, I note that ensuring banks are no longer conferred “too big to fail” status did not last very long either, as the Financial Stability Board in November, 2011 published its list of 29 Global Banks Too Big to Fail, almost a third of which are American banks.


The point of getting rid of proprietary trading is twofold. First, it was thought that banks' self-dealing had much to do with the banking and credit crises that led the nation's economy into recession late last decade. Second, is the general idea that if banks paid more attention to gathering deposits and loaning out that money as a traditional depository bank would do, banks could aid the nation's economic recovery and expansion.


The fairness inherent in the Volcker Rule is clear. Banks ought not to use taxpayer money, nor depositor money guaranteed by the FDIC, to make gambles not related to traditional banking business. Many commentators believe it was the lack of regulation, stemming from the repeal of Glass – Steagall, that opened the door to the proliferation of uncovered, proprietary bets on derivative instruments that fueled hundreds of billions of dollars of bank losses; losses that rippled through the economy. Dodd -Frank has been compared with Glass - Steagall, in that its purpose essentially is to re-regulate the banking industry, but in a 21st century manner.


To the many commentators who favor the Volcker Rule, it must be a pleasant realization that many large banks have already roughly complied with it even before the rule is ever passed. Citigroup (NYSE: C), for instance, closed its proprietary trading desk in January 2012. The proprietary desk had already been downsized since the financial meltdown last decade, and in recent months had authority of about $2 billion of Citigroup's money. That amount is a trifle of the company's overall asset level of $1.7 trillion, and I do not expect the closure to have any real impact on Citigroup's revenues or earnings, which are already as convoluted as any banks'.

Citigroup’s was simply the most recent in a string of announcements by virtually all of the nation's largest banks that they were jettisoning proprietary trading. The Volcker Rule only seeks to eliminate commingling depositor or bank capital assets with proprietary trades. Banks are free to set up hedge funds, so long as the money comes from third party sources, and continue the same bets as before. At least taxpayers or bank capital won't be on the hook.


The largest users of proprietary trades in recent years have been banks with large investment bank elements. Of course, that would put Goldman Sachs (NYSE: GS) first and foremost.  It sold the bulk of its proprietary trading operation to Kohlberg Kravis Roberts in October, 2010. Goldman Sachs also wound down other, smaller proprietary operations at about the same time. Prior to this, proprietary trading in various forms comprised nearly 20% of Goldman Sachs revenues, and nearly a third of the big firm's profits. Obviously that large a chunk of business will be difficult to make up for which will be an ongoing challenge for Goldman Sachs.

JP Morgan Chase (NYSE: JPM) also has historically had a substantial sized investment bank. Its proprietary trading operations were largely run in London, and the bank had only one U.S based trader. JP Morgan's plan was to shift those traders into an in-house, investor funded hedge fund. Those plans took a huge hit when in early March of this year the star of JPMorgan's former proprietary trading operation opted to form his own, independent hedge fund, outside of the umbrella of the bank.


Bank of America (NYSE: BAC) had a sizable proprietary operation owing to its 2008 acquisition of Merrill Lynch. Bank of America cut the manpower in its proprietary division by about a third in August, 2010. It let go of the rest of the unit in mid-2011. Again, with over $2 trillion in assets, and a slew of problems involving litigation and fines, I doubt that Bank of America will miss that proprietary unit, especially after it realizes such trading nearly put Merrill Lynch out of business before the shotgun marriage between it and Bank of America.


There is a long road with plenty of potholes ahead if the Volcker Rule were to become law. Whether that occurs or not, the elimination of depositor and taxpayer support for trades gone wrong is a net positive for the economy at large. 

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