Fed takes closer look at banks’ commodity business

The Federal Reserve is seeking input on whether it should impose tougher limits on banks’ ability to invest in physical commodities like oil, gas and metals.

The regulator unveiled a list of 24 questions for public input that dig into any potential risks tied to allowing banks to engage in the investment and trading of actual physical commodities.

In the advance notice of proposed rulemaking, the Fed noted a number of risks that financial institutions could face when it comes to trading in physical commodities. Noting recent disasters like the BP oil spill and the Fukushima nuclear power plant disaster resulted in hefty fines and settlements, which could pose a risk to the safety and soundness of banks with commodity ties.

Financial institutions are generally barred from buying physical commodities, but some exemptions have been granted over the years to permit limited activity in that area.

The Fed noted that banks have been increasing their activity in physical commodities in recent years and that the risks involved in that activity are changing.

“In light of these developments and because of the risks associated with various physical commodity activities, the Board has determined to review the scope of the activities … to ensure that they continue to be consistent with the statutory requirements that the activities be complementary to a financial activity and not pose substantial risks to the safety and soundness of depository institutions or the financial system generally,” the Fed wrote.

The practice has come under heightened scrutiny on Capitol Hill recently amid concerns such practices could lead to manipulated prices on materials that boost profits for banks. A second hearing exploring the practice is set for Wednesday at a Senate Banking subcommittee hearing.

That subcommittee hearing is set to be chaired by Sen. Sherrod Brown (D-Ohio), a longtime critic of the practice. In response to the Fed move, Brown called the decision “overdue and insufficient.”

“Each day that we wait to rein in these activities means that end users and consumers will pay higher commodity and energy prices, and taxpayers will continue to be exposed to excessive risks at Too Big to Fail banks,” he said.