Silver Bullion TV: Basel III – Not Good For Gold

In June 2019, Monetary Metals CEO Keith Weiner joined SBTV’s Patrick Vierra at The Safe House gold & silver vault in Singapore to discuss the real impact of the Basel III reclassification of gold as a Tier 1 asset.

This 6 minute excerpt begins at the Basel III portion of the interview, but you can view the entire conversation by adjusting the slider on this video. A transcript of the conversation can be found below.

After watching the video, consider if you’d like to prepare your gold-using business for Basell III’s impact before January 2022 arrives. And if you do, just schedule a call with a Monetary Metals team member to learn about options for your particular needs.

Patrick Vierra: Still a bit of a current event…Basel III. It was put in place by the G20 as a result of what happened in 2007-2008. The banking crisis. On April 1st 2019, gold was reclassified to being a tier 1 asset from being a tier 3 asset. What does that mean? The difference between a tier 3 and a tier 1?

Keith Weiner: Tier 1 and tier 3 refer to capital. Actually, the liability side. If you think about everything, I understand the bank. Everything is the opposite of how the bank,  everything is the opposite that it is to the depositor. If you think of having money in the bank, the bank owes you. So from the bank’s perspective, that deposit is a liability. So if you’re establishing a bank, you can have different kinds of capital. That is how the bank raises its funding in order to do business. So the regulators love equity capital because there’s no obligation to ever repay it back.

So if you’re the bank, you raise equity capital. The regulators are happy to let your investors’ equity capital do anything you’re well pleased to do because there’s no risk that in the funding crisis that the bank could be caught up short. So people misunderstand in the gold community, misunderstand this regulation, and they’re thinking, oh, this means that the banks can buy more gold and the regulators are blessing the purpose of gold. The tier 1 stuff that’s referring to how the banks raise their capital, which is their liability.

Gold isn’t on the liability side. The banks aren’t borrowing gold, selling gold denominated bonds or anything like that. It’s on the asset side of the bank’s balance sheet. And there you run into the problem of what’s called net stable funding ratio. So to the regulators, and this is true in reality, it’s not a regulatory artifact. There’s two different kinds of risks that can hit a bank. One risk is funding risk.

That is, let’s say a bank, goes for the absolute riskiest funding. And they borrow in the overnight funding market. What can happen and what happened in 2008 is those markets dry up. All of those funding sources pull their funding back. Meanwhile, the bank still has a long term asset. So if you borrow overnight and you buy a 30 year mortgage, you’re taking a huge risk. But eventually that will happen. And then the regulators worry about on the asset side, there’s default risk, which we just said gold doesn’t house. I think the regulators understand that. But then there’s market price volatility risk.

So if you borrow a million dollars to buy a million dollar asset, the million dollar asset drops and becomes a $900,000 dollar asset. You’re insolvent. It takes capital off your balance sheet. If that happens through other assets, you’re in trouble. And so the regulators have increased the risk rating that they put on gold and say that it needs an 85% NSFR, which means the funding that the bank gets in order to own that gold asset has to be more secure types of funding. Which basically increases the opportunity cost for the banks to own gold or a gold denominated asset, and therefore it’s going to make some banks reluctant to be in the gold business. And I think this was part of why we’ve seen a number of banks leave the gold market. And the most recent ones are two, three weeks ago now locked down.

So one by one, the banks are saying this is not a great business for us to begin with. It’s a marginal little group of 20, 30 people within, you know, an enterprise of 200,000 employees and, you know, produces marginal profits. And if the regulators make it more expensive, more annoying to do business, they say fine, we’ll exit the business.  And, you know, before that was Scotia, before that was, was it BMP? I forget which one. Couple years ago, now, before that was Deutsche. The banks are pulling out of the business because of this. And that’s going to mean higher funding costs for bullion dealers, jewelers, and everyone else.

Patrick Vierra: What does the average Joe make of this where on one hand, we’re hearing that central banks have been buying up gold left and right over the past, more so than in the past 50 years. And on the other hand, because banks now have a cost associated with holding gold, we’re seeing that perhaps not as motivated to be holding gold. On one hand, they’re buying it up. On the other hand, they’re not so interested to be in it. What do we make of this?

Keith Weiner: Well, it’s the central banks, I think, that are doing the buying, not the commercial banks. I don’t know the regulatory status for the central banks to comply with.  Basel III, I suppose probably, but I don’t know, what works in practice. I think to put that in perspective,  it may be true that some of the central banks are buying more than they have, but I don’t know that that’s a huge driver in the market today.

The gold market is very, very big. I said before, all the gold ever mined in history is still in human hands and that there are a lot of implications to that. One of the implications to that is that all of that gold is potential supply. People think, when you say gold supply, they think “whatever is coming out of the mines”, maybe some clever people will say that, you know, recycling from electronics could be added to that with all the gold ever mined in 5,000 years of human history is potential supply, at the right price and under the right conditions. And so to add to that supply, what the central banks are buying is, you know, it’s a drop in the bucket.

If you’d like to prepare your gold-using business for Basell III’s impact before January 2022 arrives, just schedule a call with a Monetary Metals team member. We’ll explain the options to match the needs of your business.