Wall Street has been lashing out against the Volcker rule since it was proposed, but a senior Goldman Sachs executive said on Wednesday the trading restriction might actually help the investment bank's profitability.
A harsh interpretation of the rule, which bans speculative trading by commercial banks, could help return-on-equity levels because banks would be able to demand more money from clients for executing trades, Goldman Sachs Group Inc. Chief Financial Officer David Viniar said at a Credit Suisse conference in Miami.
"Regulation will undoubtedly bring about new ways in which the industry must manage its operations and deliver its services to clients," Viniar said, but regulatory challenges "must be effectively navigated in order to provide shareholders with acceptable returns."
Viniar did not provide a target for Goldman's return-on-equity, but in a slide presentation he indicated that if Goldman were to exclude profits and losses from businesses affected by the Volcker rule from 2004 through 2011, the bank would have had the same average quarterly returns with less volatility.
Return-on-equity is a closely watched indicator of how well banks use shareholder money to earn profit. Last year, Goldman reported a paltry ROE of 3.7 percent, far below levels above 30 percent in 2006 and 2007.
After the financial crisis, Goldman executives forecast a return-on-equity target of 20 percent as the markets and economy became more stable. But they have since backed down from that target without offering a new one, citing uncertainty about how financial reforms will affect profits.
The Volcker rule, named for former Federal Reserve Chairman Paul Volcker, is part of the Dodd-Frank financial reform bill passed in July 2010. It is meant to prevent commercial banks that take deposits from gambling in the markets for their own accounts. The rule, due to go into effect in July, has numerous exceptions but has prompted many U.S. banks to close their proprietary trading desks.
Viniar said on Wednesday that if regulators impose strict trading limits, Goldman would be forced to turn over assets more quickly, and would be more hesitant to buy securities from clients that it could not immediately sell.
While the executive stopped short of saying Goldman would convert to an agency trading model -- which matches buyers and sellers before executing a trade -- he did indicate the bank would start buying securities at lower prices and selling them at higher prices to reflect the risk of taking on trades.
Those wider "bid-ask spreads" would make trading more expensive for clients, but help boost Goldman's returns.
Viniar also said Goldman would exit or reduce business lines that require too much capital to be profitable under new rules. This would allow the bank to put more capital to work earning profit, rather than sitting idle as reserves against risky securities, he said.
"Ultimately, it could lead to lower dealer inventory levels and could be ROE-enhancing as we adapt to a less capital intensive business model," he said.
According to a presentation the CFO gave last year, Goldman holds 32 percent of the securities on its balance sheet for at least three months, and 8 percent for at least a year. On Wednesday, he suggested that less liquid securities will not find a home on Goldman's balance sheet in the future unless the bank can demand higher rent to hold them.
"It's pretty clear the direction Wall Street is going," said Jason Graybill, senior managing director at Carret Asset Management, which invests in U.S. banks. "Pay is coming down, margin is coming down, and they have to make up for returns somehow. When he says ROEs will go up, he means relative to the last two years, not '06 and '07."
VOLCKER RULE SHOWDOWN
Viniar's comments were unusual because Wall Street executives have rarely focused on the bright side of the Volcker rule, particularly since regulators in October unveiled a 300-page proposal for its implementation, with 350 questions open to public comment.
While the Volcker rule is meant to prohibit banks from proprietary trading, implementation gets trickier when it comes to buying and selling securities for clients, because it is hard to tell whether a bank is entering a transaction speculatively or in the ordinary course of market-making.
The Volcker rule was initially controversial because when Paul Volcker proposed it to President Obama for inclusion in the financial-reform package, he wanted to entirely separate banks that take deposits from banks that trade on Wall Street.
Lobbyists for the financial industry fought hard against its inclusion in the legislation and eventually secured the modified version that prohibits proprietary trading and limits banks' investments in hedge funds and private equity funds.
Still, the unveiling of the proposed rule last October only created more of an uproar because of its length and complexity. Bankers say they fear regulators will strangle their ability to make markets for customers or hedge their own risks.
"I hope all of you ... understand how important this is, not just for your own business but for the future of the United States," JPMorgan Chase & Co Chief Executive Jamie Dimon said on a conference call shortly after the proposal was released. "And we hope at the end of the day we will be able to make markets freely."
JPMorgan bank analyst Kian Abouhoussein estimated last year that the rule would reduce U.S. banks' revenue by 12 to 46 percent, with Goldman taking the biggest hit because of its heavy reliance on trading.
The proposal has been assailed by a wide array of interested parties far beyond Wall Street.
Republicans in Congress vehemently oppose the rule for its restrictive nature, while consumer groups say it does not go far enough. John Walsh, acting director of the Office of the Comptroller of the Currency, has said the Volcker rule will put U.S. banks at a disadvantage against foreign competitors, while foreign governments and regulators worry the rule will hurt liquidity, particularly in sovereign debt markets.
Volcker himself criticized the rule at an event in November, saying it is too complicated, as did former Federal Deposit Insurance Corp Chairman Sheila Bair, who has gained a reputation as a Wall Street foe.
The public comment period for the Volcker rule ends Monday, after regulators twice extended the deadline.
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