Is There Any Gold in Basel?
The comments below are an edited and abridged synopsis of an article by Arkadiusz Sieroń
The Basel III accord is a set of financial reforms that were agreed to in 2010 after deficiencies were found in the global financial system. The idea is to strengthen bank capital requirements in order to limit risk for commercial banks and prevent a replay of the global financial crisis of 2007-2009.
Physical or allocated gold will be treated as a risk-free asset. This reform would be bullish for gold, as considering it a risk-free asset makes it less costly and more attractive for banks to hold.
The Net Stable Funding Ratio requirement obliges banks to hold enough stable funding to cover their long-term assets, and to have stable funding at 85% of unallocated gold. In other words, the precious metals transactions undertaken by clearing banks have to be backed 85% by gold.
For banks, unallocated gold will become more expensive. Some banks will exit the precious metals market, while others will be forced to increase the costs they charge or to raise the shareholders’ equity to provide the required reserves.
Basel III will be fundamentally bullish for physical gold. It will lessen the profitability of trading gold derivatives, reducing the supply of unallocated paper gold. Because physical, allocated gold is a risk-free asset, the market will move from paper gold to physical bullion, pushing its price higher.
You can be bullish without assuming price manipulation. Unallocated gold accounts are like fractional reserve banking: Banks have only part of the gold deposited at them. But now, the reserve ratio is 85%, up from 0%, which means that the supply of unbacked gold positions will diminish (or banks will have to buy more physical gold or other risk-free assets to back them). Banks will try to cover their short positions of gold, and the decrease in supply should increase the price.
Basel III could mean fewer clearing banks, higher costs charged by the remaining ones, and lower liquidity in the gold market.
Recent regulatory changes may not push gold higher, especially if expectations of the Fed’s tightening cycle increase and real interest rates rise. Later, when Basel III takes effect in the UK, we will see upward movement, as most of the unallocated gold is traded on the London gold market.