The ban on proprietary trading in the US has been supported by a study from the Government Accountability Office (GAO), an independent agency that works for the US Congress, which found that six major banks’ standalone prop desks lost almost US$16 billion in just over a year during the financial crisis.
The study looked at the standalone proprietary trading businesses of Bank of America, J.P. Morgan, Citi, Wells Fargo, Goldman Sachs and Morgan Stanley, and was commissioned to help regulators develop the rules needed to support the so-called ”Volcker Rule' that bans proprietary trading and limits investment in private equity and hedge funds. The Volcker Rule was intended to limit deposit taking institutions involvement in riskier activities and was included as part of the Dodd-Frank Act.
GAO only analysed data for standalone proprietary trading desks at the banks from June 2006 through December 2010, as it said that it was too difficult to identify proprietary trading elsewhere within firms because banks did not hold separate records for this activity.
Compared to these firms' overall revenues, the report found standalone proprietary trading produced small revenues in most quarters and large losses during the financial crisis. In the 13 quarters during this period, standalone proprietary trading produced revenues of US$15.6 billion, which was 3.1% or less of the firms' combined quarterly revenues from all activities.
This was nullified by a combined loss of US$15.8 billion in five quarters during the financial crisis, leaving an overall loss over the four-and-a-half years of US$221 million. Firms experienced lost revenue in proprietary and all other trading in 8% of the quarters analysed. Positive revenue in standalone trading only occurred in 5% of quarters and positive revenue in trading other than standalone activity occurred in 16% of quarters.
However, the report noted that one of the six firms was responsible for both the largest quarterly revenue at any single firm of US$1.2 billion and two of the largest single-firm quarterly losses of US$8.7 billion and US$1.9 billion.
The six banks' hedge fund and private equity fund investments also experienced small revenues in most quarters but somewhat larger losses during the crisis compared to total firm revenues.
Although the report said that the Volcker Rule's scope would prove effective, it said that regulators still had to get to grips with the extent, revenues, and risk levels associated with activities that will potentially be covered, so they could assess whether expected changes in firms' revenues and risk levels have occurred.
“Without such data, regulators will not know the full scope of such activities outside of standalone proprietary trading desks and may be less able to ensure that the firms have taken sufficient steps to curtail restricted activity,” it concluded.