Central Banks

Basel III and Gold Prices: What You Need to Know

Most Americans don’t give a second thought to bank regulation, and for good reason. The amount of red tape surrounding the banking and financial sector is massive. Just imagine the amount of compliance that banks have to undergo in order to stay in business.

In the US Code, Title 12 deals with banks and banking and Title 31 deals with money and finance. The Code of Federal Regulations has corresponding titles dealing with the same subjects. Then each state has its own banking regulations, and many localities have banking regulations as well.

Then you have to think about the various federal regulators, such as the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Consumer Financial Protection Bureau, each of which issues its own sets of regulations. Finally you have international organizations such as the Bank for International Settlements (BIS) that coordinate supranational banking regulations. Is it any wonder that banking seems so complex nowadays?

But while Americans don’t really pay attention to banking regulations, they’re nonetheless affected by them. And those regulations often have a spillover effect in investment markets as well.

Among the regulations getting press recently is Basel III. You may have heard of it before, or maybe not. Basel III is a set of voluntary international financial standards agreed upon by the BIS in the aftermath of the 2008 financial crisis. It sought to address shortcomings in bank capital standards so that banks would be better able to withstand another systemic financial crisis.

While Basel III was agreed to over a decade ago, its implementation continues to be delayed. Right now it’s expected to go into effect at the beginning of 2023, or in about a year and a half. And some analysts believe that the implementation of Basel III could bring about major changes in gold markets.

Getting to the Bottom of Risk Weighting

If you don’t want to read through the entire 1,600+ page Basel III Framework, you’re not alone. The document is a real mess to plow through, and without an understanding of the existing Basel framework it can be really easy to get lost in the details.

One of the key takeaways, however, is in a footnote relating to the risk-weighting of various assets. Risk-weighting is a way of determining how risky certain assets are. And depending on how risky the assets are that a bank holds, the bank may need to the amount of regulatory capital it holds.

For purposes of Basel III, a 0% risk weighting means something that is absolutely no risk, such as cash. And in general the highest risk weighting is 150%, for things such as junk bonds or sovereign bonds that are in default. The riskier the assets a bank holds, the more capital it has to hold in reserve, so the incentive is to hold less-risky assets such as cash or AA- and higher-rated sovereign bonds with a 0% risk weighting.

According to Basel III, “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%.” That means that gold not held in own vaults, or non-allocated gold, falls under the standard risk weighting for other assets, which is 100%.

According to some analysts, this could result in major changes to gold holding on the part of financial institutions. Whereas they today can hold unallocated gold or “paper gold” as an asset on their balance sheets, those now will become riskier assets under Basel III. And physical gold could now be treated as just as safe as cash.

The incentive therefore, assuming that Basel III is fully implemented, is that banks will be incentivized to hold physical gold in their own vaults, rather than purchasing “paper gold” such as unallocated gold in third party depositories. And if that happens, it could have major ramifications for world gold markets.

Demand for paper gold could drop, while demand for physical gold, and delivery of that gold, could increase. That could provide a significant boost to the gold price, which some today think is unfairly suppressed through the popularity of paper gold assets.

The Future Is Golden

Of course all of this is predicated on the implementation of Basel III. And for all we know, we could face another financial crisis before Basel III has a change to go into effect. Of course, that itself would likely lead to a boost in gold demand, so gold investors may do well in either case. But it seems that more and more the movers and shakers behind the world financial system are realizing both the importance of gold in banking as well as the necessity of incorporating it into banking regulation.

As gold continues to gain in importance and relevance in the financial system, demand and price could rise. We could very well be seeing ourselves on the verge of a revolution in the monetary system in which gold takes back its traditional role not just as a stable asset, but also as a monetary instrument. Are you prepared to take advantage of that?

Gold’s stability and maintenance of purchasing power have helped investors defend and protect their wealth over the centuries through economic turmoil and financial crises. It continues to serve that role today, and is gaining in popularity as the US economy remains weak.

If you have retirement savings and investments that you want to protect, maybe it’s time to start looking at gold before the gold price really spikes. Call the experts at Goldco today to find out how you can take advantage of gold to safeguard your savings.

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