Gold and Basel III
By Przemyslaw Radomski, CFA
Perhaps you have never heard of the
Bank for International Settlements (BIS) located in Basel, Switzerland. Perhaps
you have never heard of the Basel Committee on Banking Supervision
(BCBS), a separate legal entity with headquarters at the BIS. But these two
regulatory bodies play a considerably important role in the development of
international banking supervisory standards. And, as it happens, they also put
forward propositions on how gold is to be seen by the banks.
The BIS was set up in 1930, its
goals and means have changed throughout the years and today its main scope of
activity is to provide central banks with credit when necessary and to help in
achieving monetary and financial stability on an international level. The
BCBS was established in 1974 and is primarily concerned with coordinating
banking supervisory activities. Both BIS and BCBS are organizations with history
but neither of them have legal power to enforce any changes in the law of its
On the other hand, it proves that
the BCBS has considerable influence among
central banks all over the world. In 1988 the Committee outlined what is
currently known as Basel I – a set of recommendations on capital
requirements. Long story short, bank assets were divided into several groups
based on their perceived riskiness (bonds and gold were in the least risky
category) and banks were required to cover 8% of their assets according to a
special formula. The intuition was that at least a part of all the assets of the
banks should be backed up by assets perceived as “safe” (including gold). Even
though the BSCB did not have any regulatory power, its members adhered to its
requirements, with the level of adherence varying among the countries.
In 2004, Basel II was
introduced with more detailed recommendations on capital requirements, banking
supervision and market risk. Bank assets were divided into three categories
where Tier 1 encompassed assets perceived as least “risky” and Tier 3 comprised
of assets perceived as “risky.” The recommendations were amended multiple times;
however, they failed to adequately identify the risks associated with structured
credit products, like mortgage-backed securities. These risks were severely
underestimated or even not identified. As far as gold is concerned, under Basel
II it was treated as either Tier 1 or Tier 3 capital, since
the BCBS stipulated that:
at national discretion, gold bullion held in own vaults or on an allocated basis
to the extent backed by bullion liabilities can be treated as cash and therefore
risk-weighted at 0%.
Now, let’s make this absolutely
clear, this excerpt comes from the Basel II (!) documentation and NOT from
the Basel III one. So, depending on the decision of the country gold was
either counted as Tier 1 or Tier 3 capital already under Basel II. Gold was also
accepted as collateral with a supervisory haircut of 15%.
The financial meltdown of 2008
prompted the BCBS to revise its recommendations and postulate more restrictive
capital requirements. In 2010 the BCBS presented the first official version of
its new recommendations, which was called Basel III. Basel III abolished
the Tier 3 capital class – all assets fell either under Tier 1 or Tier 2
capital. Under these recommendations
gold remained eligible collateral with a haircut of 15% just as it was under
Basel II. Moreover, the
announcement of the U.S. Federal Deposit Insurance Corporation (FDIC) made
on June 18, 2012 and stating that gold bullion is a “zero percent risk-weighted
items” (an item perceived as “riskless,” similarly as Tier 1 capital) brought
“no change to banking capital rules with respect to gold” as
the FDIC spokesperson claimed. So, gold was considered “riskless” in the
U.S. under Basel II recommendations and it will remain considered this way under
Basel III provisions. No change has been brought about.
The situation looks slightly
different in Europe. If you remember, under Basel II gold could be considered a
“riskless” asset at national discretion. The EU consists of 27 countries,
each with its different supervisory regulations. The European Commission did not
automatically consider gold a “riskless” asset, but charged the European Banking
Authority (EBA) with the task of identifying
which assets are to be legally deemed “riskless.” On the other hand, the
European Parliament expressly pointed to gold as a highly liquid asset that
should be taken into consideration by the EBA. The EBA review is scheduled to
end in 2015,
gold is however, already recognized as collateral.
If you feel in any way lost in the
jungle of banking regulations relating to gold, do not worry, we have pointed
out the most important things you need to know:
III does NOT, in any significant way, change the way the U.S. regulator sees
has NOT become the legal tender in any country adhering to the Basel III
III is NOT a shift toward a gold standard, contrary to what has been rumored.
general regulatory trend in the EU seems to point to the inclusion of gold as
a “riskless” asset.
What does all of this mean for you?
Generally speaking, if gold is officially confirmed as a “riskless” asset by the
EBA, then an increase in demand for gold may be seen in the EU. Such an
increase, however, would not be a main driver of the price of gold. So, Basel
III is not a major factor in the continuing gold bull market. Favorable
fundamentals for gold, even without a positive impact from Basel III, are
still in place and the long-term trend remains up.
If you have enjoyed this commentary,
please check our research essays on
gold in Fort Knox and on
gold and the dollar collapse. For a more practical view on how we see
investments in gold and silver, refer to our essay on
gold and silver portfolio.
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