Financial sector stocks and exchange traded funds stumbled Friday as the so-called Volcker Rule was leaked. It is part of the Dodd-Frank financial-overhaul package.

Financial Select Sector SPDR Fund (NYSEArca: XLF) dropped over 3% on Friday as worries over U.S. banks’ exposure to Europe’s credit crisis and global slowdown also weighed.

The Volcker Rule, an addendum to the Dodd-Frank Act and named after former Federal Reserve chief Paul Volcker, will prohibit large banks from most speculative trading and limit their investments in hedge funds and private-equity funds in an attempt to mitigate financial risk.

Volcker previously argued that banks engaged in proprietary trading took on higher-than-necessary risks in chasing down profits, report Scott Patterson and Victoria McGrane for WSJ.com.

A leaked draft memo stated that banks “must be designed to generate revenues primarily from fees, commissions…or other income not attributable to appreciation in the value of covered financial positions it holds in trading accounts.” Wall Street observers fear that this may force banks to shrink their trading desks, which would diminish profits and overall market efficiency.

Many large U.S. banks have already undergone changes ahead of the new regulations, according to the report. However, the impact to the profitability and risky behavior will be hard to gauge until after the rule is implemented sometime next year.

Showing Page 1 of 2