Source: LA Times

A top government banking regulator wants Senate Democrats to let banks keep most of their business in complex — and profitable — securities known as derivatives.

A sweeping overhaul of banking regulations pending in the Senate would require banks to spin off their derivatives business.

Sheila Bair, the chairwoman of the Federal Deposit Insurance Corp., said that provision could shift the creation of derivatives contracts outside the reach of regulators.

“If all derivatives market-making activities were moved outside of bank holding companies, most of the activity would no doubt continue, but in less regulated and more highly leveraged venues,” Bair wrote in a letter to Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) and Agriculture Committee Chairwoman Blanche Lincoln (D-Ark.).

The derivatives measure pushed by Lincoln would require banks to set up separate subsidiaries, with their own source of capital, to run what has been a highly profitable derivatives business. Derivatives are the complex speculative and risk-hedging instruments blamed for helping plunge Wall Street into a near meltdown in 2008.

The Obama administration also has indicated it does not support the provision. The FDIC is at least the second bank overseer to oppose the ban. Federal Reserve officials, in a letter to senators, also have called on the Senate to remove the spin-off requirement.

Dodd agreed to keep that restriction after negotiating with Lincoln last weekend. The decision stunned the bank industry, which immediately mobilized to get it removed.

But even if that provision is ultimately removed, there is bipartisan support for restricting banks from trading in derivatives with their own accounts for purely speculative purposes.

Indeed, in her three-page letter, Bair said that neither banks nor bank holding companies should engage in speculative derivatives trading. But she said banks have a legitimate need for derivatives to help them hedge against interest rate fluctuations.

Moreover, she said, banks “play an essential role” creating markets for commercial firms that enter into derivatives contracts to manage their risks.

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