Basel III rules provide huge potential catalyst for higher gold prices

In January 2013 new rules which are part of the global regulatory standard for banks are due to come into effect. Known as “Basel III”, the new rules substantially increase the existing capital requirements for banks, however they also contain a huge potential catalyst for the price of gold.

Overview of Basel III

Basel III will require banks to:

  • Increase their common equity from 2% under Basel II to 4.5%
  • Increase their Tier 1 capital of risk-weighted assets (RWA) from 4% to 6%
  • Introduce a mandatory capital conservation buffer of 2.5%
  • Maintain a minimum 3% leverage ratio
  • Hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days

However the new rules, which where agreed upon in September 2010 by the members of the Basel Committee on Banking Supervision, also contain a huge potential catalyst for the price of gold.

Currently gold is rated as a Tier 3 asset, which means that banks can only carry 50% of its market value as capital, something which reduces the desire for banks to hold gold. However, from 1 January next year, gold will be rerated as a Tier 1 asset, meaning that it can be carried at 100% of its value.

Not only will this double the value of the gold held by the major banks, allowing them to lend more money, it also means that as far as banks are concerned gold will be rated as the equivalent to cash. Essentially gold is about to become money again.

And it’s not just banks that are realizing that gold is as good as cash. On 25 May 2011, the European Parliament’s Committee on Economic and Monetary Affairs (ECON), agreed to accept gold as collateral.

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