WASHINGTON (Reuters) - Washington policymakers should tighten the Volcker rule's ban on risky bank trading by reining in a key exemption for hedging activity, former bank regulator Sheila Bair said on Thursday.
Industry players, however, raised concerns that financial markets would suffer if the exemption was highly restrictive.
Speaking at a roundtable hosted by the Commodity Futures Trading Commission, Bair said Volcker rule exemptions should be strictly defined.
"I would tighten the rule," she said. "A hedge should not be allowed unless it is a hedge."
Bair, who stepped down as chairman of the Federal Deposit Insurance Corp last year, has been an outspoken critic of Wall Street excess.
But financial industry players at the roundtable said that a very narrowly defined hedging exemption would damage liquidity, increase costs to market participants, and discourage hedging.
"There is no hedge you can put in place that does not create another risk," said Josh Cohn, counsel to the International Swaps and Derivatives Association, which is currently challenging a CFTC rule on position limits in court.
The Volcker rule is part of the 2010 Dodd-Frank financial reform law and has been seen as a critical tool to rein in the type of excessive risk-taking that fueled the financial crisis.
The forthcoming rule, formally proposed by regulators in October, would ban banks that receive government backstops such as deposit insurance from trading for their own account.
It includes key exemptions to allow banks to hedge risk and make markets for customers seeking to trade securities.
Banks' lobbying efforts for broader carve-outs have been weakened since JPMorgan Chase & Co announced earlier this month it lost at least $2 billion on a botched hedging strategy. Since that announcement, potential losses have mounted.
CFTC Chairman Gary Gensler said he did not intend to discuss JPMorgan's recent trading loss, but said it may be instructive for regulators as they finalize the Volcker rule.
Bair said hedges should be publicly disclosed and banks should continuously disclose how a hedge is performing. She added the rule should ban any compensation based on profits from the hedges.
"A good hedge should lose money," she told the panel.
Bankers at the roundtable argued that definition was too simplistic.
"Just because a hedge desk happens to make money for one month or one quarter...doesn't necessarily mean that that is a profit center," said Dan Rodriguez, a chief risk officer at Credit Suisse.
The Volcker rule was slated to be finalized by July but regulators have indicated they will likely miss the deadline. Banks will have until 2014 to fully comply.
Editing by Leslie Adler