Volcker warns against controversial derivatives provision in Wall St. reform

Paul Volcker, adviser to President Barack Obama and former Federal Reserve chairman, is warning against a controversial provision in the Wall Street overhaul that would limit commercial banks' use of derivatives.

"The provision of derivatives by commercial banks to their customers in the usual course of a banking relationship should not be prohibited," Volcker wrote to senators in a letter obtained by The Hill. The letter was sent on Thursday.

Senate Agriculture Committee Chairwoman Blanche Lincoln (D-Ark.) has backed controversial legislation aimed at limiting banks from having derivatives operations in house. The "spin off" provision has quickly become one of the most controversial aspects of the Wall Street bill.

Volcker said he is, "aware of, and share, the concerns about the extensive reach of Senator Lincoln's proposed amendment."

Federal Deposit Insurance Corporation (FDIC) head Sheila Bair warned against the provision last weekend.

Lincoln said in a statement Friday she would continue to support her legislation.

"I have great respect for Chairman Volcker and agree with his proposal to require banks to push out certain trading operations," Lincoln said. "Like him, I believe that banks need to get back in the business of banking and my provision gets us closer to this goal by separating swap dealing operations from banking operations. I also agree that we can, and should, encourage banks to manage their considerable risk. My provision would preserve a bank's ability to use swaps to hedge their risks - not doing so would be foolish. Absent my provision, however, we have not done enough to address the massive size of entities that became so large that taxpayers were left with no option but to bail them out. My provision begins to cut down the size of these institutions by moving this risky activity into fully regulated entities, protecting American taxpayers." 

Some Democratic and Republican senators have expressed concern with the provision, including Sens. Judd Gregg (R-N.H.), Mark Warner (D-Va.) and Kirsten Gillibrand (D-N.Y.).

This story was updated at 1:55 p.m.