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Proprietary trading

Limiting bank investments that don't benefit customers

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Washington Post Staff Writer
Friday, January 22, 2010

President Obama proposed Thursday that banks should be restricted from making investments that are not intended to benefit customers, an activity known as proprietary trading.

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Experts caution, however, that the rule may be hard to write.

Proprietary trading originated with a practice that clearly benefited customers.

Most money that banks collect from depositors is lent to borrowers, but banks place some money in safe investments such as government bonds that can be sold easily when depositors want money.

In recent decades, however, many banks sought higher returns by making riskier investments. These trends were amplified as banking companies grew more complicated, drawing funding from more sources and investing in a wider range of activities.

Increasingly, some investments were made to profit the firms' employees and shareholders, unrelated to the needs of customers.

During the financial crisis, banks such as Citigroup lost billions on such investments while others such as Goldman Sachs made billions. And the government was forced to spend billions rescuing the industry.

Bank executives acknowledge that some activities are easily distinguished as being solely for the benefit of the bank. Goldman Sachs estimated Thursday that 10 percent of its revenue came from such activities. Sources familiar with J.P. Morgan's operations estimated that less than 1 percent of the company's revenue might be affected by such a restriction. People familiar with Bank of America's operations also gave an estimate of less than 1 percent.

But the lines are fuzzy. Banks often make proprietary investments to offset the risk of other deals, for example. And investing still serves its original purpose of keeping money easily at hand while buttressing the bank's financial condition.

"It's an arbitrary decision whether you say it's a proprietary investment to maximize return, or part of an overall policy to benefit customers," said Douglas J. Elliott, an expert on financial policy issues at the Brookings Institution.

He added that any line regulators draw could be easy to subvert, as banks could simply reclassify transactions.

-- Binyamin Appelbaum


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