Banks are finding their way around the Volcker Rule in some unexpected ways. JPMorgan's recent windfall off the Swiss franc—and Citi's loss—is testament to that fact.
JPMorgan is also finding its way around the Volcker Rule.
Earlier this month, traders at the nation’s biggest bank made $300 million in one day, following news that the Swiss central bank was taking its cap off the franc. That caused the currency to soar, and JPMorgan JPM traders took the move, literally, to the bank.
If you have been following financial regulation since the financial crisis—and who hasn’t—or even just read the headlines, this might seem odd. One of the concerns after the financial crisis was that banks were taking too much risk, particularly with government-backed consumer deposits. So, as part of the Dodd-Frank reform law, Congress passed the Volcker Rule, which bans banks from engaging in risky trading. Presumably, this rule would make big paydays like a $300 million gain on a 30% move in the franc not possible.
It was clear from the start that the Volcker Rule had some very large loopholes. But recently, banks are finding their way around Volcker in some unexpected ways. Last week, The New York Times reported that Goldman Sachs was “on a shopping spree with its own money,” buying up mostly commercial real estate but also pieces of some private equity-type investments. But it wasn’t an official private equity fund, so it’s okay.
There’s trading, and then there’s trading. The Volcker Rule was not supposed to stop banks from executing client transactions, which is trading, but supposedly the good, not so risky, kind. But allowing that kind of trading and not the other risky, bad kind was always the big problem with the Volcker Rule. Nearly every bank has announced that they are shutting down their proprietary trading desks, which might give you the impression that the Volcker Rule is working. But JPMorgan made $2.5 billion in fixed income revenue in the last three months of 2014 alone, which seems like an awful lot of money from just doing good, risk-less trading.
JPMorgan could claim that they made the $300 million from collecting commissions on client trades. Matt Levine of Bloomberg ran the math and says it’s possible, but unlikely. But that doesn’t explain what happened to Citigroup C , Deutsche Bank, and Barclays. Those banks lost a total of about $400 million on moves related to the Swiss franc. Clearly, that bank was risking some money in the market.
None of this likely breaks the Volcker Rule, at least not directly. The rule has a loophole that allows banks to trade currencies, but only in the spot market, which is day-to-day trading. Banks are not allowed to buy futures contracts, which involve more leverage, and typically more risk.
But banks still have to make money, and they typically want to make as much as they can. So they are taking much large positions in seemingly safer markets, and trades. Given that JPMorgan made $300 million, it likely had about $1 billion riding on a rising Swiss franc. Citigroup had more betting the opposite way. According to Citi’s last quarterly statement, it believed the most it was likely to lose based on its position on any one day in the currency market was $32 million. JPMorgan put its currency trading risk at just $8 million a day.
But as a few weeks ago showed, these currency markets weren’t as safe as they seemed. The result was a bigger than expected loss for Citi, Barclays, and Deutsche—and the opposite for JPMorgan. The Volcker Rule has limited the amount of risk banks can take, but it hasn’t eliminated it. It’s not clear the banks know that.
Editor’s note: A previous version of this story incorrectly noted that Citigroup had lost $400 million on trading activities related to the Swiss franc. In fact, those losses were incurred by a Citigroup, Barclays, and Deutsche Bank.