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Definition: Volcker Rule
Originally proposed by the US Federal Reserve Chairman Paul Volcker, the Volcker Rule aims to discourage commercial banks (with certain explicit exceptions) from investing the depositors’ money into other money making instruments like hedge funds, private equity funds etc and through proprietary trading (also called as Speculative Investments).
The Volcker Rule proposes to limit the functioning of commercial banks to their traditional business in which they would earn profit by charging higher interest rate on loans than on deposits. It tries to delineate clearly the retail and investment wings of commercial banks.
The Volcker Rule was proposed as a reform tool of the US banking industry whose erratic behaviour in terms of favouring riskier investments and indulging in unfair business practices led to the financial crisis of 2008.
Paul Volcker was appointed as the Chairperson of the President’s Economic Recovery Advisory Board in February 2009. The Board was to advise the President measures for Economic Reforms. The Volcker Rule is a section of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Although Volcker Rule has been endorsed by the US Administration led by the President Barack Obama, it has received severe criticism from many finance professionals and analysts. Critics say that the rule would severely limit the profitability of banks and their options to mitigate the risks associated with the banking industry. Also it would hurt the proprietary traders through cuts in their commission and income.