Proprietary Trading and the Volcker Rule

Before 2010, the line between a bank trading on behalf of its clients and a bank trading purely for its own speculative profit — using the bank's own capital, with the bank keeping any gains or absorbing any losses directly — was considerably blurrier than it is today. Proprietary trading, or "prop trading," refers specifically to that second category: a bank deploying its own capital for its own direct profit, distinct from facilitating client trades or providing the market-making liquidity function covered elsewhere in this module.

The Volcker Rule, part of the 2010 Dodd-Frank Wall Street Reform Act, generally restricts banks from engaging in this kind of proprietary trading, along with restricting bank ownership and sponsorship of certain hedge funds and private equity funds. It's named directly after Paul Volcker — the same real historical figure covered elsewhere on this platform for his dramatic, deliberate interest rate hikes as Fed Chair from 1979 to 1981, aimed at breaking runaway 1970s inflation — who, decades later, proposed this specific reform in the aftermath of the 2008 financial crisis. The underlying concern: banks taking large, speculative proprietary trading risks with their own capital, capital ultimately backed in part by federal deposit insurance and implicit government support, could create outsized risk to the broader financial system, with taxpayers ultimately exposed if those bets went badly wrong.