Is Gold under Basel III at Risk?

Gold not require term funding!

Recently Dr. Keith Weiner, CEO- Monetary Metals and the president of the Gold Standard Institute USA inks, Will Basel III Send Gold to the Moon! He said, “A number of commentators have predicted that the rules of the Basel III bank regulations will cause gold to skyrocket (no, this article is not about our view that gold does not go up, that it’s the dollar going down, that the lighthouse does not go up, it’s the sinking ship going down in the storm).”

Will it? It would be easy to say as with all of their other predictions of gold to infinity and beyond, “wait and see.” But where’s the fun in that? We’d rather look into the nature of the claim, how banks operate, and what the regulation actually says so who wants to understand a bank balance sheet, and regulators’ view of bank risk? In other words, who wants to understand whether gold will skyrocket?

If you picture the bank getting pinched by twin pincers, that’s right. One is that funding is pulled by bank creditors, while the other is that the bank struggles to sell assets to repay them. And now we get to gold. Commentators have been claiming that under Basel III regulations gold will soon be a “tier 1 asset”. To go back to our favorite quote from physicist Wolfgang Pauli, that’s not even wrong. Here tiers refer to a bank’s capital which means its liabilities. How it funds its portfolio of assets. This is not where gold fits.

Gold under Basel III, Gold is an asset. Under the new regulations, gold is assigned a Required Stable Funding of 85%. This is up there with equities. In other words, regulators see it as risky to hold gold, so they want to make sure that banks fund it mostly using liabilities that cannot be pulled with expensive liabilities.

The gold community should not be cheering this as good for gold. We should be screaming bloody murder. Gold is not risky, like equities. Gold has no default risk, and its price risk is not that high. In fact, if a balance sheet holds a small amount of gold, it acts as a hedge. It reduces drawdowns.

The World Gold Council submitted comments to Federal Reserve, on the proposed rule "Enhanced Prudential Standards and Early Remediation Requirements…” It argued that gold should be included in the definition of “highly liquid assets”, and should not require term funding under the Net Stable Funding Ratio.

The World Gold Council included quotes from HSBC, UBS, and other banks and banking associations, as well as the London Bullion Market Association. They each argue for a low or zero Required Stable Funding. Basel III assigns gold an 85%, which is the opposite of low.

Focusing on The Physical vs Paper Gold Nothing burger he inks, we did come across one other error from the golderatti, which we think is worth noting. Much ado was made of the distinction between paper gold vs. gold bars held in a bank’s vault or in trust.

This, it was argued, will disincentivize the bank from trading paper gold. We are told that suppresses the price, and browbeaten with the false claim that each physical ounce is “papered 92 times over”. Instead, according to this misconception, banks will want to own real gold bars in preference to paper contracts.

However, the Office of the Comptroller of the Currency, the Fed, the FDIC, and the Office of Thrift upervision, put out a document that shows otherwise: “A bank may assign a risk-weighted asset amount of zero … for gold bullion held in the bank’s own vaults or held in another bank’s vaults on an allocated basis, to the extent the gold bullion assets are offset by gold bullion liabilities [emphasis added].”

Yes, a gold metal asset has the same zero risk-weighting as cash, if the gold asset is funded by a gold liability. What is a gold liability? It is everything that the gold commentariat hates: short gold futures positions, gold swaps, etc. In other words, it’s the carry trade that we write about every week in our Supply and Demand Report!

Banks can own physical and sell futures, to make a small spread. In this case, the banks don’t need to reserve extra funding for gold, as the market risk of the gold price is hedged. In the parlance of our day, this whole assertion of physical gold being treated preferentially to paper is a big nothing burger.

We will just say that, unlike a junk bond, gold has no risk of default. And unlike real estate, gold has no risk of widening bid-ask spreads. [Readers’ note: Search full ink as, ‘Will Basel III Send Gold To The Moon’ by Keith Weiner]