Volcker rule threatens sovereign debt liquidity-BoJ

(Reuters) – The Volcker rule crackdown on banks’ trading activities could affect the liquidity of sovereign debt markets, a top Bank of Japan official warned U.S. regulators on Monday.

Liquidity could be hit if the Volcker rule does not exempt foreign debt from banks’ trading restrictions, Kiyohiko Nishimura, the Bank of Japan’s deputy governor said at the Institute of International Bankers conference in Washington.

U.S. regulators are under pressure to craft the Volcker rule so that it does not restrict trading in countries’ foreign debt. The Dodd-Frank law, enacted in response to the 2007-09 financial crisis, provides an exemption for trades in U.S. debt but not securities issued by other countries.

There has been some debate over how much legal authority regulators have to extend the exemption for sovereign debt beyond the United States.

Although Nishimura said he “fully agreed with the reasoning” behind the Volcker rule, the Japanese central banker said U.S. regulators had to be careful to avoid unintended consequences.

“Most of the new regulatory frameworks are not being introduced in normal times, but in a stressed time,” he said. “The best prevention may not be the best response to a crisis.”

The Volcker rule restricts banks ability to trade with their own funds for profit and it also greatly limits their ability to invest in hedge and private equity funds.

It is named after former Federal Reserve Chairman Paul Volcker who championed the idea.

Opponents say it is too restrictive and could drive up the cost of borrowing. Proponents say it is a needed curb on risk taking by banks that enjoy government backstops like deposit insurance or access to loans from the Federal Reserve.

Dodd-Frank specifically exempts U.S. debt from the Volcker rule but regulators can only extend the exemption to other countries’ debt if they determine that doing so would protect the financial stability of the United States and the safety and soundness of banks.

At the conference, U.S. Treasury Assistant Secretary for Financial Markets Mary Miller was asked if regulators have the flexibility under the law to expand the exemption beyond U.S. debt or whether Congress would need to change the law for this to happen.

Miller said she believes the law gives regulators the flexibility they need if they decide to expand the exemption. “I do think that agencies can probably address that,” she said.

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