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June 26, 2021, 1:14 p.m. EDT

Why Basel III regulations are poised to shake up the gold market

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Myra P. Saefong

New banking rules, part of a sweeping international accord known as Basel III, will come into effect on Monday and mark a big change for European banks and their dealings with gold — potentially altering the landscape for precious metal demand and prices.

Like many reforms put in place over the past decade that aim to avert another global financial crisis, the new banking rules come with some controversy — and caveats.

Allocated gold, in tangible form, will essentially be classified as a zero-risk asset under the new rules, but unallocated or “paper” gold, which banks typically deal with the most, won’t — meaning banks holding paper gold must also hold extra reserves against it, said Brien Lundin, editor of Gold Newsletter. The new liquidity requirements aim to “prevent dealers and banks from simply saying they have the gold, or having more than one owner for the gold they have” on the balance sheet. 

In response to the global financial crisis of 2007 to 2009, the Basel Committee on Banking Supervision, which sets standards for regulation of banks, developed what is called Basel III . It’s defined by the Bank for International Settlements as an internationally agreed set of measures that aim to strengthen bank regulation, supervision and risk management.

In its essence, Basel III is a multiyear regime change that aims to prevent another global banking crisis, by requiring banks to hold more stable assets and fewer ones deemed risky.

Under the new regime, physical, or allocated, gold, like bars and coins, will be reclassified from a tier 3 asset, the riskiest asset class, to a tier 1 zero-risk weight —putting it “right alongside with cash and currencies as an asset class,” said Adam Koos, president of Libertas Wealth Management Group.

Since physical gold will have a risk-free status, this could cause banks around the world to continue to buy more, Koos said, adding 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.

Allocated gold is owned directly by an investor, in physical form, such as coins or bars. Unallocated gold, or paper contracts, often are owned by banks, but investors are entitled to that gold, and avoid storage and delivery fees. 

Under the new rules, paper gold would be classified as more risky t han physical gold, and no longer counted as an asset equal to gold bars or coins.

Liquidity requirements

As part of the Basel III reforms, European banks will face new liquidity requirements, known as the Net Stable Funding Ratio (NSFR) .

It’s a liquidity standard that banks must follow to ensure adequate stable funding to cover their long-term assets. The ratio is the amount of available stable funding relative to the amount of required stable funding , which should be equal to at least 100% on an ongoing basis.

NSFR regulations will be introduced to banks in the European Union on Monday, the U.S. on July 1, and in the U.K. on Jan. 1, 2022, according to Alasdair Macleod, head of research at Goldmoney Inc.

The objective of the NSFR is “oblige banks to finance long-term assets with long-term money” to avoid liquidity failures that were seen during the 2007/2008 global financial crisis, according to the London Bullion Market Association (LBMA) .  

“It affects all bank liabilities and assets” and the objective is to ensure that bank assets are “properly funded and that depositor withdrawals will not lead to bank insolvency and the transmission of systemic risk,” said Macleod.

The new rules will mainly impact banks and their unallocated gold, as the majority of regular investors tend to hold physical, allocated gold, analysts have said.

New liquidity ratio requirements imply that banks may “need to set aside more funding for ‘unallocated’ gold,” analysts at BofA Global wrote in a Monday note.

Raising funding requirements for unallocated gold means the financial institution would either “reduce the bullion business” or “sustain activity and put more funding aside,” said analysts at BofA.

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Myra P. Saefong is on the markets team in San Francisco. She has covered the commodities sector for MarketWatch for more than 10 years. She has spent the...

Myra P. Saefong is on the markets team in San Francisco. She has covered the commodities sector for MarketWatch for more than 10 years. She has spent the bulk of her years at the company writing the daily Futures Movers and Metals Stocks columns and has been writing the weekly Commodities Corner column since 2005. Myra has been with MarketWatch since 1998 and holds a master’s degree in English literature.

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