Basel III and Gold
What are the Basel III Regulations?
Last month, the long awaited banking rules known as Basel III Regulations were implemented for European banks. This is major shift for European banks and how they work with with gold. This is “potentially altering the landscape for precious metal demand and prices” as Market Watch has stated in the past.
In essence, Basel III classifies allocated gold, in physical form, as a zero-risk asset under the new rules. However unallocated “paper” gold, will not be classified this way. What this means is, banks holding paper gold must also have physical reserves to back it. These new regulations strive to “prevent dealers and banks from stating they have the gold, or having more than one owner for the gold they have” on the balance sheet.
Bank of America’s explanation
- If the gold is held in allocated form, a specific bar is attributed to the client. The bank effectively acts as a custodian, with the precious metal held off balance sheet. This also means that banks cannot access the gold for their own business activities.
- If customers of a bank hold gold in an unallocated account, they essentially are an unsecured creditor. Gold held in unallocated accounts, similar to currency deposited, can be used by banks for their normal conduct of business. As such, unallocated gold is fungible and can be used to clear and settle physical metal transactions. Because of this, it provides the liquidity essential for the clearing and settlement system (similar to fiat money which is frequently rehypothecated hudnreds of times among its various claimants in a fractional reserve system). The LBMA points out that this allows clearing banks to debit/credit market participants’ accounts with metal immediately, even before the seller’s metal is delivered to the buyer. [That’s because there is no actual gold being moved around, just promises of said gold]
Many of those bullish on gold have been eagerly awaiting this transition since physical gold will have a risk-free status. Basel III could cause banks around the world to continue to buy more, Koos said. He Also noted that central banks already have stepped up purchases of physical gold to be held in the institutions’ vaults, and not held in unallocated, or paper form. Inversely, under the new rules paper gold would be classified as more risky than physical gold. Paper gold will no longer counted as an asset equal to gold bars or coins.
The Basel Committee on Banking Supervision
The Basel Committee on Banking Supervision which sets standards for regulation of banks, developed what is called Basel III in response to the global financial crisis. The Committee designed Basel III as a multiyear change with a goal to prevent another global banking crisis. This will be requiring banks to hold more stable assets and fewer ones deemed to be risky.
What this means for gold is that under the new standards, physical, or allocated, gold, like bars and coins, will be will no longer be deemed a tier 3 asset, the riskiest asset class, and will now be classified as a tier 1 zero-risk weight. This puts it “right alongside with cash and currencies as an asset class,” said Adam Koos, president of Libertas Wealth Management Group.
