We can only speculate about the real purpose for the Volcker Rule. 

It is generally acknowledged that proprietary trading did not cause or contribute to the Great Recession. Furthermore, the rationale that banks should not be allowed to use insured deposits to engage in high-risk speculative trading is misleading because depositories were never allowed to do that under laws predating the Volcker Rule by decades. The real target of the rule, presumably, is the trading activities of bank affiliates.

Some think Paul Volcker really intended to restore the original intent of the 1956 Bank Holding Company Act: isolate banks from every other form of commerce.  The Volcker Rule would do that by making it such a nuisance to be affiliated with a bank that only a shell holding company would do it. Some lawmakers may have supported the Volcker Rule in reaction to the scandal surrounding a securities firm using its proprietary trading desk to bet against securities it was selling to some of its clients.

I think the best case for the rule is to prevent a bank affiliate from engaging in activities that pose a risk to the affiliate's solvency when that is a risk to the bank as well. The London Whale is a case in point. If enough bad trades had been made to bankrupt the holding company, it could cause a run on the bank even if it is otherwise solvent.

Regulators have a legitimate interest in overseeing investing activities that threaten a bank. The biggest problem with the regulators' proposal to put the Volcker Rule into practice is that it goes much further than needed to provide this oversight.  Its excessive, almost punitive, reach is one of its biggest flaws.

Here are two changes that would accomplish legitimate goals with much less confusion and disruption.

First, acknowledge that not all affiliate investment activities present a risk to the bank and those that do not should not be subject to the rule.

Many industrial banks are part of much larger and diversified corporate groups that include a multitude of affiliates with nothing to do with the bank except being owned by the same parent. One example is a technology company that invests a small amount of its assets in new companies developing related kinds of technology. These pose no threat to the affiliated bank but would be significantly affected if subjected to the rule.

Many investments by parent companies also pose no threat to the bank. One example is an investment in a local economic development venture capital fund sponsored by a state. Typically these investments could be a dead loss and it would not affect the parent company in any material way. What is the rationale for banning this kind of investment? 

The Volcker Rule would also apply to any investor holding an interest of 10% or more of the bank's parent company. A mere shareholder in a holding company can fail without affecting the bank. Imposing the rule on investors only drives capital away from all but the largest banks where investors never get close to the control threshold. Cutting access to capital for smaller banks is a good way to ensure that too big to fail banks continue to grow and smaller banks do not.  There is just no valid reason to subject mere investors to the rule. 

A better approach than extending the rule to all affiliates is to have the bank do something similar to what it does in connection with Regulation O. The bank's board should periodically identify all affiliates whose solvency could pose a risk to the bank. The regulators could then oversee all investment and other activities at those affiliates to ensure that they are conducted prudently and safely. Within that world the different scenarios are too diverse to fit a simple formula such as a “trading account” (another major flaw in the rule) so prudence and safety should be determined on a case-by-case basis.  Those that pose no risk to the bank would be left alone. Regulators would have the authority to make any inquiries they want to ensure that no affiliate is improperly left off the list.

Most important, the zealous overreach infecting the entire rule in its proposed form must be purged. Liquidity investments provide another good example. The draft regulation has a provision defining liquidity as only the cash needed to pay short-term debts. It does not extend the exception for such investments to excess cash and other assets.

The rationale is that excess liquidity should be allowed to be invested only in U.S. government securities because it presents an opportunity to engage in speculative, high-risk trading. That is just nuts. Holding excess liquidity and capital is not unsafe, unsound or undesirable. Excess liquidity makes a bank or other entity stronger and should be encouraged, not banned.  

Scrapping the current version of the rule for one that gives bank regulators the clear authority to supervise activities of affiliates that pose a risk to the bank is a better option.  

George Sutton, a former Utah commissioner of financial institutions, is an attorney at the law firm of Jones Waldo in Salt Lake City who represents Utah industrial banks.