Former Federal Reserve Board Chairman Paul Volcker objected to a provision in the regulatory reform bill that would force banks to spin off their swaps desks.

In a letter dated Thursday to Senate Banking Committee Chairman Chris Dodd, Volcker said he agreed with regulators who warned it could drive derivatives trading to less regulated parts of the economy.

"I am also aware of, and share, the concerns about the extensive reach of Senator Lincoln's proposed amendment," Volcker wrote. "The provision of derivatives by commercial banks to their customers in the usual course of a banking relationship should not be prohibited."

The provision is championed by Agriculture Committee Chairman Blanche Lincoln, who is fighting efforts to remove it from the bill.

Volcker said he sympathized with the intent of the provision, but said another amendment by Sens. Carl Levin and Jeff Merkely to ban proprietary trading would better address the issue. Volcker first suggested a ban on proprietary trading last year — a provision now known as the Volcker Rule.

"My understanding is that the prohibitions already provided for in Section 619, specifically including the Merkely-Levin amended language clarifying the extent of the prohibition on proprietary trading by commercial banks, satisfy my concerns and those of many others with respect to bank trading in derivatives," Volcker wrote.

In response, Lincoln issued a statement that said she had "great respect" for Volcker, but said her provision was essential to protecting the banking system. "My provision would preserve a bank's ability to use swaps to hedge their risks – not doing so would be foolish," she said.

"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."

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