How Basel III Will Impact Gold-Using Businesses

Last year, Monetary Metals’ CEO Keith Weiner wrote an article debunking the idea (popular at the time) that Basel III regulations would send gold’s price to the moon. The focus of that piece was on the investors and individuals who own gold.

This time, we’ll look at the same subject, but from the perspective of companies who use gold to earn their profits. Since the bulk of this activity occurs at, with, or through bullion banks, that’s where we will begin.

What Do Bullion Banks Do?

Bullion banks are generally divisions of investment banks that provide services specifically around precious metals. They can be market-makers with activities such as clearing and trading, or they can finance gold businesses, such as miners, refiners, and mints. They use proprietary gold, client gold, or leased gold from a central bank and other entities.

However, holding gold on the bank’s balance sheet is not the same as holding cash. It’s more expensive and therefore requires the bank to earn a return sufficient to justify holding it.

What Do Regulators Focus On? Enter the NSFR

Regulators want to make sure that in times of stress, banks remain solvent. In other words, a bank’s assets must cover its liabilities, and they need to consider that those assets are more likely to be withdrawn during times of panic.

The Net Stable Funding Ratio (NSFR) is an attempt to measure this. If the NSFR is at least equal to 1, then the bank should be able to withstand short-term withdrawals in times of market stress.

According to its methodology, some liabilities can’t be withdrawn immediately. This makes them stable. Examples include equity and long-term bonds. On the other hand, demand deposits and interbank overnight loans can be withdrawn immediately. This makes them unstable.

Similarly, some assets are more reliable than others. Short-term assets, such as cash, are completely reliable. You can use its full value in a crisis. Long-term assets, such as 30-year mortgages, are less reliable.  You may not be able to sell them at all, or only at a steep discount.

The most unreliable assets have their full value discounted when calculating the bank’s NSFR. This is represented in the Required Stable Funding (RSF) number. Cash has a 0% RSF. 30-year mortgages have a 100% RSF.

Other assets fall somewhere between these two extremes, such as loans to financial institutions maturing in six to twelve months. These have a 50% RSF.

Cost Implications of the RSF

The most reliable sources of funding are also the most expensive, such as equity and long-term bonds. The bank may hold a 100% RSF asset against them, since 0% of their value is subject to short-term redemptions in times of crisis.

Conversely, demand deposits are one of the most unreliable sources of funding and one of the cheapest. Therefore, only assets with a 0% RSF can cover them in times of crisis.

Thus, the higher the RSF, the more expensive the liability must be to fund it.

Gold under Basel III

Which brings us to gold. Currently, gold has a 50% RSF. The cost of its liability counterpart is somewhere above a demand deposit but below equity or a long-term bond.

If a bank cannot earn a sufficient return on its gold assets to cover the cost of funding, then it doesn’t make sense to have the gold. This fact puts a floor under the rate banks require when leasing or lending gold.

When Basel III becomes active in January 2022, gold’s RSF will change. It will increase from 50% to 85%, making it more expensive for banks to hold. At the very least, banks will require an even higher return on their gold leases and loans.

What This Means for Gold-Using Companies

Two related consequences follow from this change.

First, some bullion banks will close because their former business model for leasing gold will no longer be viable, or sufficiently attractive.  Scotiabank is an example. After 23 years of operating, it plans to shut down its bullion bank business by 2021.

Secondly, the banks that remain will be forced to increase their financing rates not to profit, but just to break even.

So, businesses on the other end of this financing – such as mints, miners and refiners – will be faced with higher funding costs. Or they will lose their banking relationship altogether. These are often low margin businesses, so any increase in interest expense will eat into an already slim profit margin.

Ultimately, the higher rates will move some businesses from the “viable” category, into the “no longer viable” one.

An Alternative to Bullion Banks

Monetary Metals offers secure, predictable, and reliable sources of funding for gold-producing and gold-using businesses. We are not a small department within a large institution, but a growing, entrepreneurial business – focused exclusively on financing companies that use precious metals productively.

If your business uses precious metals, you may soon need to make a decision – with limited options. You can either compete for scarcer and more expensive bullion capital, or find a new source of funding.

Monetary Metals is an attractive alternative to traditional forms of funding. Our gold and silver leases are reliable, flexible, and safe.

We can supply the capital you need as your business grows, and be your long-term financing partner.

To learn more about how we compare to other financing options, visit this page. Or schedule a call with one of our team members.