Washington policymakers should tighten the Volcker rule’s ban on banks’ speculative trades by reining in an exemption for hedging activity, former U.S. bank regulator Sheila C. Bair said Thursday.

Speaking at a roundtable hosted by the U.S. Commodity Futures Trading Commission, the former chairman of the Federal Deposit Insurance Corp. said that exemptions to the Volcker rule should be strictly defined and that banks should have to publicly disclose their hedges.

“I would tighten the rule,” she said. “A hedge should not be allowed unless it is a hedge.”

Banks have actively lobbied for broadly defined exemptions, but those efforts have been weakened since JPMorgan Chase announced last month that it lost at least $2 billion on a botched hedging strategy. Since that announcement, potential losses have mounted.

The Volcker rule, part of the 2010 Dodd-Frank financial reform law, has been seen as a critical tool to rein in the type of excessive risk-taking that fueled the financial crisis.

The forthcoming rule would ban banks that receive government backstops such as deposit insurance from trading for their own account. Regulators issued a Volcker rule proposal in October that vaguely allowed for key exemptions to allow banks to hedge risk and make markets for customers seeking to trade securities.

CFTC Chairman Gary Gensler said that Thursday’s roundtable was not convened to specifically discuss JPMorgan’s recent trading loss but that the revelation may be instructive for regulators as they finalize the Volcker rule.

Gensler also acknowledged that it will be challenging for regulators to ban proprietary trading while still allowing for protective hedges.

Despite the JPMorgan trading debacle, the financial industry on Thursday said that a very narrowly defined exemption would damage liquidity by discouraging banks from making markets and hedging risk.

“A diversified bank is a safer bank,” said Shawn Johnson, investment committee chairman of State Street Global Advisors.

He said banks would become more vulnerable to crises if they “go backwards” and concentrate primarily on taking deposits and making loans to avoid violating a tough Volcker rule.

Bair and other reform advocates disagreed.

“My ideal world would be insured banks would be restricted to traditional commercial banking,” Bair said.

To strengthen the Volcker Rule, hedges should be publicly disclosed, and banks should continuously disclose how a hedge is performing, she said.

The Volcker rule was slated to be finalized by July, but regulators have indicated they will probably miss the deadline. Banks will have until 2014 to fully comply.

— Reuters