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Rethinking the Volcker Rule

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Rethinking the Volcker Rule

Mercatus Center,

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Market participants could realize the objectives of the Volcker Rule by monitoring banks’ risk.

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To protect consumers following the 2008 financial crisis, the United States introduced the 2010 Dodd-Frank Act containing the Volcker Rule, which forbids financial institutions that rely on deposit insurance from proprietary trading. The aim was to reduce the moral hazard that entices banks to take excessive risks. Authors Hester Peirce and Robert Greene condemn the Volcker Rule and assert that market participants, not regulators, should monitor banks. Though always politically neutral, getAbstract believes this provocative article will ignite debate among economists and policy makers across the political spectrum.

Summary

When the Great Depression wreaked havoc on the American economy, the US government established deposit insurance to curtail future panics and bank runs. However, such protection spurs moral hazard: Investors are less likely to scrutinize banks when they know their savings are secure, and banks are more prone to risk taking when no one is watching. An international study found that deposit insurance increases risk taking by banks and that the level of deposit coverage is negatively correlated with bank stability.

The 2010 Dodd-Frank Act contains the Volcker Rule, which – due to concerns that risky bank...

About the Author

Hester Peirce is a senior research fellow at the Mercatus Center, where Robert Greene is a research associate.

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