by Robert Lambourne, Gold Seek:
This note considers the potential impact of the “Basel 3” regulatory standards of the Bank for International Settlements on the bank’s own gold banking business, which is of interest to gold investors mainly due to the regular trading the BIS does in gold swaps and other derivatives.
These gold transactions by the BIS are perhaps the most obvious sign of regular and often extensive if usually surreptitious gold trading done by central banks.
This trading in gold by the BIS is not consistent with the claim that gold is no longer of significance in the world financial system. A review of the BIS’ use of gold swaps as at February 28, 2021, is here:
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Documentation relating to Basel 3 is extensive and it reflects the difficulties in regulating banks and other modern financial enterprises. The BIS’ summary of the Basel 3 standards is here:
While it is frustrating to read such a vast swathe of bureaucratic pronouncements, regulatory rulings can have a large effect on real economic activity, as is highlighted in the instructive video presentation by Miles Harris here:
An example Harris gives is that a more relaxed regulatory attitude toward mortgage lending has buoyed housing markets in many countries. His presentation deals mainly with how Basel 3 could affect monetary metals:
Despite the difficulties in reading and understanding the documentation on Basel 3, the following conclusions may be drawn about it:
— Implementation of Basel 3 is being carried out via national regulators adopting the new BIS standards into their rules, with some differences in implementation schedule.
— The date for implementation of Basel 3 has been delayed by the BIS until January 1, 2023. The U.K. is heading toward implementation a year earlier. This early implementation is still provisional, as representations on its application can be made until early May 2021.
— All forms of gold, including physical, are required to be at least 85-percent funded with Tier 1 capital in accordance with the Net Stability Funding Ratio (“NSFR”) introduced in Basel 3. There is no reference in Basel 3 to physical gold being a Tier 1 asset itself.
— This funding requirement has upset the London Bullion Market Association (LBMA), and the association considers that Basel 3 is likely to reduce gold trading among the association’s members, which is done mostly via unallocated gold accounts. Some historical comments from the LBMA on its desire to reverse the Basel 3 rules on the treatment of gold are here:
— For those banks that trade gold assets, there are exemptions from the NSFR to the extent that there are gold liabilities to offset the gold assets.
Before considering the impact on the BIS’ gold banking business, note that Basel 3 will also have an effect on the bank itself because of the gold bullion it holds for its own account. The latest published report from the BIS, the half-year report to September 30, 2020, reveals that the bank held 102 tonnes of gold for itself:
This gold will require 85% funding via Tier 1 capital. As a practical matter this seems unlikely to cause any concerns for the BIS, as it already reports extensive margins of safety in all its current risk reporting, which is not yet covered by Basel 3 requirements.
The original BIS gold banking business prior to 2009, before the bank started using gold swaps regularly, was essentially straightforward and allowed central banks securely to deposit unallocated gold via the BIS at major gold trading centers without any political risk.
Hence a central bank would deposit gold in a sight account at the BIS (gold sight accounts are unallocated gold), the BIS would then open a sight account at, say, the Federal Reserve Bank of New York, and the gold would be held by the Fed in unallocated form on behalf of the BIS.
This meant that the BIS had effectively no exposure to gold price risk, and in the eyes of all the Basel accords, including Basel, 3 the bank would have no credit risk or political exposure, since the Fed is always considered sure to return what it holds in custody. The central bank making the original deposit into the sight account at the BIS would have avoided any political risk that the Fed would not return its unallocated gold.
This route protected unallocated German gold held by the Bank of England during World War II, when German gold was placed in a sight account with the BIS, which then placed the gold in a sight account at the Bank of England.