European governments warn that the regulation could further aggravate their debt crisis, which is already roiling global financial markets.
The Volcker Rule, which was included in the Dodd-Frank overhaul of financial regulation passed by Congress in response to the financial crisis, bans banks from speculating with their own money. The idea was that banks can pose too much risk to the financial system if allowed to pursue such trading.
Regulators are now working to finalize rules that distinguish between when a bank is buying and selling for a customer, which would still be allowed, and when it’s betting for its own gain.
The draft rule released by regulators late last year created a few exemptions, allowing banks to continue speculating on U.S. government bonds and most municipal bonds. But the proposal extended the ban to hundreds of billions of dollars worth of other municipal securities, as well as bonds issued by foreign governments.
Municipalities and foreign governments alike are complaining that the rule would significantly curtail the purchase of their bonds by banks, increasing the interest rates that bond issuers may have to pay to attract investors.
From Texas to Europe to Malaysia, officials have been lobbying U.S. regulators to change the proposed Volcker Rule to avoid these consequences. The European Union and Japan sent officials to lobby U.S. regulators last week in Washington.
Regulators generally believe they have struck the right balance in terms of limiting risk-taking as Congress directed in the Dodd-Frank legislation while also preserving enough flexibility for banks to trade in municipal securities and foreign bonds.
But they have left the door open to possible changes — which could range from exempting additional categories of bonds because regulating them so tightly could pose risks to the financial system or other changes in the language of the Volcker Rule. They have not committed to any changes, however.
Federal regulators will release a final version of the Volcker Rule in coming months before it takes effect July 21. They have declined to comment publicly on the rule while it is still under discussion. A spokeswoman for the Federal Reserve said “all comment received will be evaluated before the board acts on the rule.”
On Friday, Treasury Secretary Timothy F. Geithner, who is helping to coordinate the writing of the new rule, said on CNBC that as regulators work to implement the rule and limit the risks that banks can take, they will be working to preserve “well-designed, carefully constructed exceptions for market-making hedging.”