What is the Volcker Rule?

By Motley Fool Staff Markets Fool.com

The Dodd-Frank Act may have been passed into law nearly seven years ago, but that doesn't mean it's no longer in the headlines. Case in point: Since the new presidential administration came into power, it's promised to deregulate the financial services industry, bringing the Dodd-Frank Act back into focus.

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In this episode of Industry Focus: Financials, The Motley Fool's Gaby Lapera and John Maxfield discuss what this means for the Volcker rule, which limited banks' ability to operate like hedge funds.

A full transcript follows the video.

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This podcast was recorded on Feb. 13, 2017.

Gaby Lapera: I want to move on to the next thing, which is the Volcker Rule,which I think a lot of people have heard about, but maybe don't understand. The Volcker Ruleprohibits proprietary trading,limits the relationship between banks and hedge funds,and I believe it also prevents banks from trading certain types of assets. Thisproprietary trading issomething that sounds like a buzzword,but it means something very specific, which is when the bank uses the bank's money to invest,instead of just facilitating investing for their clients.

John Maxfield:That's right. Banks can'tgo out and act like a hedge fund anymore, where you'regoing out and buying super risky assets. What they can do now is serve as market makers, which means you'rejust facilitating. So, let's say you're aBank of America, for example, and you have theseinstitutional investor clients like aninsurance company that wants to sella whole bunch of government bonds that it owns. You can't just sell $100 million worth of government bonds,it's not like buying and selling a stock. Youhave to have somebody who'll actually facilitate that transaction. So, it will sell those bonds toBank of America, and then Bank of America will find a buyer for those bonds, so,it just facilitates that transaction. That's what market making is, and that's what the Volcker Rule limits bank's' rolein the capital markets to.

Lapera:Right. And banksmake their money from fees generated from that, andmaybe a commission or something. But before, withproprietary trading, they were actually taking consumers' money, likedeposits or whatever,and then investing in the stock market and saying, "Lookhow much money we made with your money!" Andthat leads to some very risky practices,like you saw before the recession, that ran his headlong into a concrete wall.

Gaby Lapera has no position in any stocks mentioned. John Maxfield owns shares of Bank of America. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.