Will Congress Exempt Small Banks from the Volcker Rule?

WASHINGTON — Support for fully exempting community banks from the Volcker Rule continues to grow, but advocates fear it could be waylaid by a larger fight in Congress over changes to the Dodd-Frank Act.

Lawmakers are gearing up for a debate over modifications to the 2010 financial reform law, and relief efforts for smaller financial institutions are expected to be central to that fight. The Senate Banking Committee has scheduled two hearings on the issue, on Feb 10 and Feb. 12, and it's likely that changes to the Volcker Rule will be among the many small-bank provisions discussed.

Several prominent regulators including Federal Reserve Board Gov. Daniel Tarullo of the Federal Reserve and Comptroller of the Currency Thomas Curry have already thrown their support behind efforts to carve out smaller institutions from Dodd-Frank's ban on proprietary trading. One of the law's lead authors, former Rep. Barney Frank, is also backing the effort.

"I agree with Dan Tarullo and Tom Curry about the $10 billion and under [banks] on the Volcker Rule fix," Frank said in a recent interview, building on earlier support for the move. "I think some people have been lawyered into doing more than they have to, and it's fine to make it explicit."

To be sure, regulators released guidance with the Volcker Rule that exempts institutions with fewer than $10 billion from meeting compliance requirements if they aren't involved in any activities under the law, outside the trading of state and municipal bonds and related securities.

"The vast majority of these community banks have little or no involvement in prohibited proprietary trading or investment activities in covered funds," the community bank guide says.

The problem, critics say, is that small banks still have to go through the process of analyzing their trading and investments to ensure their activity is exempt.

"It's not as though, if you're one of those banks, you don't have to pick up the Volcker Rule — you have to pick up, figure it out and decide that you're not doing those things," said Oliver Ireland, a partner at Morrison Foerster. "You've got to read this rule — this rule is painful, it's hundreds of pages of explanations, and key information is stuck in the hundreds or thousands of footnotes."

Smaller banks still engaged in included activities under the rule may add language to existing policies rather than starting from scratch while larger banks have to write separate compliance programs regardless of their activity.

Banks are broadly required to comply with the rule by this summer, meaning the clock on a fuller carve-out for smaller institutions is already ticking.

Some, including the Independent Community Bankers of America, are pushing for a much higher exemption from the Volcker Rule for institutions under $50 billion, which is the current cutoff for banks designated as systemically important.

"It's our position that Chairman Volcker himself and the rule named after him was really targeted at the largest, most systemically risky banks in the world and that it was never meant to apply to banks that are below what I'd call the SIFI line," said Camden Fine, president and chief executive of the Independent Community Bankers of America.

Helping small institutions is a rare bipartisan cause in Congress in recent years, but it's unclear if Democrats are willing to agree to an alternation of Dodd-Frank, particularly when it comes to the Volcker Rule. President Obama has said repeatedly he will veto bills that significantly roll back the law, but what constitutes a major "unraveling" versus more minor modifications remains to be seen.

A bill exempting thesmallestinstitutions from the Volcker Rule may not raise objections on its own, particularly given the backing of key regulators and other officials, but some warned that it provides an opening for critics to push forbroader exemptions, say above $10 billion, and evenbigger changes to the rule.

"It's like opening Pandora's box when revisiting Volcker," said one senior Democratic aide, who spoke on the condition of anonymity.

Regulators have already made several changes and enacted delays for the rule since the final regulation was released in December 2013.

For example, banks can now keep legacy collateralized debt obligations backed by trust-preferred securities, and they've been given an additional two years to comply with provisions dealing with some covered funds, including certain collateralized loan obligations, with a new compliance deadline of July 2017.

At the same time, further legislative efforts to slow down implementation of the law have come under fire this year.

Democratic lawmakers in the House initially torpedoed legislation that included another two-year delay of the Volcker Rule provision on legacy CLOs last month, describing it as a loophole designed to help Wall Street. (The bill ultimately passed the House under regular order, which requires a simple majority of votes, but has not been taken up in the Senate.)

The fight to exempt smaller institutions may also provoke broader discussion around the general use of asset cutoffs in banking rules. Some industry proponents have begun pushing regulators to look at business activity rather than size when determining which institutions need to comply with various rules, including SIFI designations for banks.

"Efforts to move numbers around will help some, and will harm others," said James Ballentine, executive vice president of congressional relations and political affairs at the American Bankers Association. "That's the danger with setting these numbers — until there's a rationale around what an institutions does and the activities it's involved in, it's a false premise rather than an objective way of look at it."

Still, those watching the issue said they expect legislation will emerge soon, noting that language is still being worked out. Where lawmakers will draw the line — at $10 billion, $25 billion or even higher — remains to be seen.

"I am committed to taking a serious look at all bills and proposals to move through my subcommittee that can help provide regulatory relief for Main Street financial institutions, increase consumer financial choice, and jumpstart economic growth," said Rep. Randy Neugebauer, R-Texas, chairman of the banking panel's financial institutions and consumer credit subcommittee, in a statement to American Banker.

It's likely that any provision exempting small institutions from the Volcker Rule would initially be considered as part of a larger package of reforms, rather than as a standalone bill. But should efforts at broader legislation ultimately fail, there could be more of a push for individual provisions to move on their own. Whether that comes in time to help community banks trying to make sense of the Volcker Rule is unclear.

"As Congress looks to write a larger bill, they'll want as many sweeteners as possible to attract supporters," said Brian Gardner, an analyst at Keefe, Bruyette & Woods. "If you do this as a standalone, it weakens the appeal of a larger bill that doesn't contain this."