Witnesses testifying before the House Financial Services Committee Wednesday warned lawmakers that the controversial Volcker Rule could tighten bank liquidity and make U.S. financial institutions less competitive with banks overseas.

Once finalized by regulators, the rule – unless modified or repealed by lawmakers – will enact a provision under the Dodd-Frank Act that prohibits U.S. banks from engaging in short-term proprietary trading practices.

Proprietary trading takes place when banks risk their capital to profit from the purchase and sale of short-term securities and derivatives.

Financial reformers criticized short-term proprietary trading in certain financial products – namely agency mortgage-backed securities – for helping balloon the sovereign securities market and siphon capital from banks during the financial crisis.

Except for outgoing Rep. Barney Frank (D-Massachusetts), few lawmakers and regulators offered to endorse the Volcker Rule.

“I’m not sure [proprietary trading] did contribute to the financial crisis,” committee chairman Rep. Spencer Bachus (R-Alabama) said in opening remarks. “This rule will threaten the United States and its capital markets, the most liquid in the world.

“Proprietary trading contributes to that liquidity,” he added.

FDIC acting director Martin Gruenberg offered up a defense of the rule, saying that it would allow “banking entities to continue to engage in permitted activities, including bona fide market making and underwriting activities… and facilitate robust and liquid capital markets.”

The rule rolls forward despite countervailing views and an extended lobbying campaign by industry groups from around the country.

The Office of the Comptroller of the Currency (OCC) fueled concerns about liquidity and capital requirements last October when it released a study that said the Volcker Rule would rack up $1 billion in related expenses for banks.

Speaking at hearing, OCC acting comptroller John Walsh said that his agency felt “particularly concerned with how to strike the right balance in identifying and preventing impermissible activities without undermining activities that are safe, sound and profitable and help to reduce a bank’s overall risk profile.”

He expressed interest in “whether comparably effective compliance results could be achieved through less burdensome approaches,” along with concerns that the Volcker Rule could make U.S. lenders less competitive with foreign institutions.

Douglas Elliott, a fellow in economics with the left-leaning Brookings Institution, called for an outright repeal of the Volcker Rule.

Absent a repeal of the rule, he said that regulators should include an exemption for financial institutions with certain investments in asset- and mortgage-backed securities, saying that anything to the contrary could weaken bankers.

His conclusion seemed to capture the mood of several lawmakers and witnesses.

“These four sets of flaws lead me to believe that the Volcker Rule will do a poor job of identifying or eliminating excessive investment risk, will be costly even when it correctly identifies risk, and will be even more costly when it discourages risk that is incorrectly treated as if it were excessive,” he said.