Major financial regulation
created after the 2008 crisis as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010).
It was named after Paul Volcker, the former Chair of the Federal Reserve.
What The Volcker Rule Does
It restricts banks from taking certain risky actions with their own money.
Specifically, it bans two things:
- Proprietary Trading (Prop Trading): Banks cannot trade stocks, bonds, derivatives, or other financial instruments for their own profit.
Before 2008, banks used customer deposits (insured by FDIC) to make huge risky bets.
Volcker Rule stopped this.
2. Owning or Investing in Hedge Funds or Private equity Funds
Banks cannot
- Own hedge funds
- Own private equity funds
- Invest heavily in them
- Or secretly run them
Why?
Because banks were hiding risky trades inside these funds (like selling those CDS to Mr. Burry’s hedgefund).
Why this Rule exists?
During the pre-2008 boom, large banks like Goldman Sachs, Merrill Lynch, Lehmar, Citigroup, and others were:
- using depositor money to gamble
- making highly leveraged bets
- loading up on mortgage derivatives
- selling toxic products while betting against clients
The Volcker Rule tries to separate traditional banking (safe) from Wall Street trading (risky)—similar to what the old Glass-Steagall Act did before it was repealed.
In simple terms, the Volcker Rule says:
If you’re a bank that takes deposits from everyday people, you cannot gamble with that money.
Who It Applies to:
- Large commercial banks (e.g., JP Morgan Chase, Citi, Bank of America, Wells Fargo)
- Bank affiliates overseas
- Bank holding companies
It does not apply to:
- Hedge funds
- Private equity funds
- Investment forms without insured deposits
Are There Exceptions to this Rule?
Under this rule, banks can still do the following:
- Market-making (providing liquidity)
- Hedging for legitimate risk reduction
- Trading U.S. Treasuries
- Trading on behalf of clients
I remember, a friend telling me she threw in $5,000 into stocks through her Chase bank mobile app. They asked whether she preferred low, medium or high risk for a shot at higher returns. Well, she was pretty sure, she’s in the right place at the right time—so, she thumbs-up the high risk button like she was ordering a chipotle burrito (high risk for a heartburn). I thought that was exciting and easy, you don’t have to do any research on the stocks.
As consumers, we kind of hold a trust that banks should be smarter enough to make the high risky bets a good one.
Under this rule, banks just can’t take speculative bets with their own capital.
Has the Volcker Rule been weakened?
According to reports, under the Trump administration (2017-2019), parts of the Volcker Rule were relaxed, especially for smaller banks. But the core prohibition on Prop Trading remains.
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