WASHINGTON — Federal Reserve Board Chairman Ben Bernanke said Thursday that U.S. regulators are carefully examining recent criticisms raised by foreign governments in how their sovereign debt will be treated under the proposed 'Volcker Rule.'
Bernanke, who was testifying before the Senate Banking Committee for his second appearance on Capitol Hill this week, received a number of questions from lawmakers about the proposal released last November by the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller.
The plan, named after former Fed Chairman Paul Volcker, would ban banks from proprietary trading and limit their investments in private-equity and hedge funds. Lawmakers have focused on the issue given numerous industry objections and complaints by foreign counterparts.
Many of those questions seemed to circle around the number of governments from the European Union, Canada, Japan, and others that have become increasingly vocal about the fact that their sovereign debt will not be exempted from the proposal. In contrast, U.S. Treasury securities, are exempted under the plan.
"They believe they're being discriminated against and that the 'Volcker Rule' might affect the liquidity and effectiveness of their sovereign debt markets," Bernanke said. "We take this very seriously. We are in close discussions with those counterparts."
The Fed has received thousands of comment letters on the proposal, with many arguing it would unintentionally harm liquidity, widen spreads and increase volatility at foreign institutions. Critics also argue foreign sovereign debt should get the same favorable treatment the proposed rule gives U.S. Treasury bonds.
Bernanke said U.S. regulators would remain flexible if adjustments to the rule were required in order not to unnecessarily damage those markets.
"And of course, we will be looking carefully to see if changes are needed and we'll do what's necessary," he said.
Sen. Jack Reed, D-R.I. appeared to have his own set of reservations about the treatment of foreign sovereign debt given the ongoing crisis in Europe.
"European governments are urging that their sovereign equities be sort of treated preferentially in the rule, even though … under the Basel rules there's a zero risk-weighting to sovereign debt," Reed asked Bernanke. "So, the Greek debt has no risk?"
Bernanke explained that European banking authorities are currently forcing banks "to write down their sovereign debt. And that, in turn, affects the amount of capital they can claim."
Others like Sen. Bob Corker, R-Tenn. were concerned about the depth of liquidity in other instruments outside of the Treasuries and mortgage-backed securities, which are exempted under the rule.
"There's certainly a trade-off. There's going to be at least some marginal effect from Volcker on markets," said Bernanke. "In principle, there's a market-making exemption, as you know, and we're going to try and do our best to clarify the distinction between proprietary trading and market making."
Regulators have previously expressed the difficulty in making such a distinction — a point the chairman raised during before the House Financial Services Committee on Wednesday.
But Bernanke made clear that the intent by U.S. regulators in writing the Volcker rule was to limit risk, not market-making by institutions.
"The goal of the Volcker rule is to reduce risk taking by institutions and we're trying to do that in a way that will permit hedging and market making," said Bernanke. The Fed, he said, pushed for those two exemptions during the early stages of the regulatory reform process.
At Tuesday's hearing, Bernanke warned that it was unlikely regulators would able to deliver a completed rule by the July 21st deadline required under Dodd-Frank.
But the chairman made sure to assure lawmakers — without providing a deadline — that regulators would be working round the clock to finalize the rule.
"We will be working as quickly and effectively as we can to get it done," said Bernanke.
He also told lawmakers like Sen. Mike Crapo, R-Idaho that regulators would give U.S. institutions plenty of time to adopt the rule after it was ready — even if they passed the statutory deadline in July.
"We certainly don't expect people to obey a rule that doesn't exist," said Bernanke. "We will certainly make sure that firms have all the time they need to respond. I think two years will probably be adequate in that respect."
Under the rule, regulators are required to provide institutions two years to adjust to the new requirement.
Separately, Sen. Richard Shelby, R-Ala. questioned Bernanke on a separate regulatory matter — a vice chair position at the Fed to head bank supervision, which has gone unfilled for the last two years.
Bernanke explained that the duties are currently being distributed across the Fed between governors and staff, but the point person has been Fed Gov. Daniel Tarullo, who heads the bank supervision committee, and he would like to see an appointment.
"Congress created the position and yes, I'd like to see it filled and I'd also like to see the Board filled as well," said Bernanke.