How A Community Bank Tripped On Footnote 1,861 Of The Volcker Rule

· Jan. 10, 2014, 10:31 pm

When people talk about the Volcker Rule, they often mention JPMorgan Chase, the giant bank where a trader recently made a bad bet that lost $6 billion. The Volcker Rule is supposed to put an end to that sort of thing, by prohibiting banks from trading with their own money.

But some banks that are very, very different from JPMorgan Chase are struggling with an obscure provision in the rule. Specifically, footnote 1,861, which bars banks from investing in something called trust-preferred securities — a rather obscure investment favored by lots of small, community banks invest

Tioga State Bank is headquartered in Spencer, a village in upstate New York with a population of about 800 people. The bank mostly makes loans to local people and businesses. But Richard Fisher, bank’s president, says trust-preferred securities make up a large chunk of his bank’s annual income. “It’s a big deal,” he told me.

Nathan Stovall, who covers the banking industry for SNL Financial, says the regulators just don’t want banks investing in anything that could even smell risky.

“What they’re trying to do is say, ‘We want you to be a lender, period. And since you’re investing some of those deposits in bonds, we want it to be in really vanilla stuff,’ ” Stovall said.

The American Bankers Association does not consider these particular investments risky, and is challenging the rule, saying some community banks could have to close their doors over this footnote in the rules. And the regulators and Congress are reconsidering.

It turns out, it’s hard to figure out which risks banks should be allowed to take, and which they shouldn’t.

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