The US Federal Reserve has issued proposed regulations that would effectviely restrict physical commodities activities by banks. By requiring greater reserves for physical commodities trading than more traditional banking activities such as commercial loans, the proposal seeks to appropriately reflect the comparative risk. Far more importantly, the proposal will reduce the advantage that banks with physical commodities activies have in trading and financial commodities activities.
The long-awaited regulation would require banks to put up much more capital to support investments in physical commodities, restrict involvement with power plants and limit the amount of trading banks can do. While the Fed doesn’t have the power to sever banks’ ties to physical commodities, it is seeking massive capital increases for the activities -- especially at Goldman Sachs and Morgan Stanley, which have special legal exemptions to stay in those businesses. Fed officials estimated that the rule would mean about $4 billion in additional capital for the industry’s current level of investment, though Wall Street has been steadily backing away. Though it’s unstated, the proposal also addresses years of criticism that banks could seize unfair advantages in metal and energy markets by owning hard assets and operating huge trading desks at the same time.