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Glass-Steagall Works in China; Volcker Rule M.I.A. on Wall Street

Nov. 29, 2016 (EIRNS)—China’s banking system, which by some estimates has issued $20 trillion in credit for economic expansion since 2008, nonetheless has an exposure to derivatives in the low single-digit trillions of dollars nominal value, of the Bank for International Settlements’ estimated $600 trillion global derivatives total.

Nonetheless China, which has had legislative separation of commercial banks from shadow banks on the Glass-Steagall model since 1993, is further tightening up on commercial banks’ derivatives exposure. The China Banking Regulatory Commission (CBRC) is doing what the Federal Reserve was tasked to do by the original Glass-Steagall Act—protecting commercial banks from themselves, limiting them to loans and generally sound investments.

CBRC’s new regulations circulated Nov. 28, according to Xinhua, set much more detailed guidelines on how banks must calculate their financial exposure to counterparty risk, in both exchange-traded options/futures and over-the-counter derivative contracts on interest rates, etc. Xinhua reports that the new rules raise the bank’s capital reserve requirements for derivatives positions, and,

"compared with current requirements, set clear standards on what risk factors should take precedence under which circumstances. This reduces ambiguity that has been exploited by some banks to understate the risk they actually face in the derivatives business."

China’s banks had just $1.4 trillion in nominal derivatives exposure in 2012, but this 0.33% of the global total has grown somewhat since, and CBRC is toughening its already tough restrictions on commercial banks’ derivatives trading.

The United States, to avoid restoring Glass-Steagall, adopted the Volcker Rule in 2010. By now, even its creators have developed existential doubts as to its existence. Two new examples reported Nov. 28 by Seeking Alpha show why.

First, Goldman Sachs found that one trader, Thomas Malafronte, made $250 million in profit for the firm this year by trading junk bonds—recall that Volcker "forbids" banks’ proprietary trading for their own accounts. But Goldman "conducted an internal investigation and concluded Malafronte did not violate the so-called Volcker Rule."

In addition, at Citigroup, a team of derivatives traders on its U.S. dollar interest-rate swaps desk made $300 million in profit for the bank this year. (At what expense to their clients?) Again, the "so-called" Volcker rule did not come into play.

The Volcker Rule may now be slated for revocation—neither Trump nor the GOP Congressional leadership want it—but its departure may not make any noticeable difference. Admitting this, one of its two designers, Sen. Jeff Merkely of Oregon, has signed onto the Senate Glass-Steagall bill.