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Fitch: New Volcker rule may increase market liquidity, mask proprietary trading

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Fitch: New Volcker rule may increase market liquidity, mask proprietary trading

The recently updated Volcker rule could lead banks to enhance their roles as market makers and increase market liquidity, but its relaxed compliance standards could help them conceal heightened levels of proprietary trading, Fitch Ratings said in an analysis.

The Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. approved a second version of the Volcker rule, which prohibits banks from making trades using their own money. The rewrite aims to ease banks' burden of proving that their trading activities are not proprietary.

"With Volcker 2.0, banks are more generally presumed to be innocent unless proven guilty," Fitch Ratings Managing Director Christopher Wolfe said in the research note.

Notably, the new rule repeals the "accounting prong," which banks have criticized as being too burdensome. It also rearranges compliance thresholds for banks based on their trading assets and liabilities. Now, banks with between $1.0 billion and $20.0 billion in trading assets and liabilities will be subject to a less-onerous compliance standard.

Fitch said the rule may encourage banks to engage in certain algorithmic trading strategies that were previously banned under the old rule. This will allow banks to better compete with high frequency trading firms, Fitch said.

The agency said that there were no immediate rating changes related to the rule, but it would negatively view banks that increase trading activity that could be perceived as proprietary. Fitch also said that any increase in proprietary trading may fail to generate adequate returns on capital due to heightened capital and liquidity standards.

The Volcker rule rewrite needs approval from the Securities and Exchange Commission, Federal Reserve Board of Governors and the Commodity Futures Trading Commission in order to become official.

Moody's previously said the new Volcker rule could be a credit negative for banks, as it may open the door for excessive risk-taking, especially in a low-interest-rate environment.