WASHINGTON — Federal Reserve Board Gov. Sarah Bloom Raskin urged regulators to narrow a proposed exemption to the Volcker Rule, saying it may allow banks to avoid compliance with the ban on proprietary trading.

In a speech late Monday, Raskin — the only Fed governor to dissent on the draft plan released in October — detailed her objections to the proposal, suggesting it did not go far enough.

"I was concerned that, as proposed, the guardrails were too broad and would allow banks to be able to go too far off the road," said Raskin. "Further, I was concerned that the guardrails as crafted could be subject to significant abuse — abuse that would be very hard for even the best supervisors to catch."

The Dodd-Frank Act required regulators to ban proprietary trading, but created several exemptions to allow firms to continue to engage in certain hedging and market-making activities.

"Federally insured financial institutions and their affiliates can operate in narrow circumstances along the lines of a low-road banking model where there are sufficient guardrails in place to protect the integrity of the banking system," said Raskin. "These guardrails are those limited exemptions based on safety and soundness and financial stability."

Bankers have argued that the proposal would reduce liquidity in financial markets, an idea challenged by Raskin. Rather, she said it was traditional banking done by community banks that ends up promoting liquidity through deposit-taking and lending.

"Sure, liquidity in opaque financial markets may have increased in recent years by virtue of proprietary trading, but how has this market liquidity benefited consumers, retail investors, small business owners, and homeowners?" she said.

She also noted that the proposal, named after former Fed Chairman Paul Volcker, would not entirely wipe out proprietary trading by all firms, only banning it for federally insured banks and their affiliates. She said investment banks, hedge funds and other nonbank financial market participants would in theory still be able to promote liquidity through proprietary trading.

"Any supposed impact by the Volcker Rule on overall market liquidity or credit spreads is, to me, questionable," said Raskin.

Still, Raskin said, certain markets should feature large credit spreads because they involve truly risky products.

"A reduction in proprietary trading may have the effect of increasing spreads, but that is actually a public benefit, not a cost, because those wider spreads will more accurately reflect the risk involved in those positions," said Raskin.

While banks backstopped by government funding will be limited in their ability to conduct market making activities, she said that will create "market pressure for financial instruments that present proprietary trades to move to established exchanges where transparency is enhanced and exposure to counterparty default risk is greatly reduced."

Most importantly, she said such activities should not wind up putting taxpayers on the hook.

"Certain capital market activities for federally insured banks should not be supported by vast amounts of public and private expenditure," said Raskin.

Regulators have already missed the statutory deadline to finalize the Volcker Rule by July 21. It is unclear when the agencies will release a final rule, but they said in April it will not take effect until July 21, 2014.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.