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Thursday
Nov292012

Gold: Solution to the Banking Crisis

 

By: Eric Sprott & David Baker

The Basel Committee on Banking Supervision is an exclusive and somewhat mysterious entity that issues banking guidelines for the world’s largest financial institutions. It is part of the Bank of International Settlements (BIS) and is often referred to as the Central Banks’ central bank. Ever since the financial meltdown four years ago, the Basel Committee has been hard at work devising new international regulatory rules designed to minimize the potential for another large-scale financial meltdown. The Committee’s latest ‘framework’, as they call it, is referred to as “Basel III”, and involves tougher capital rules that will force all banks to more than triple the amount of core capital they hold from 2% to 7% in order to avoid future taxpayer bailouts. It doesn’t sound like much of an increase, and according to the Basel group’s own survey, the 100 largest global banks will only require approximately €370 billion in additional reserves to comply with the new regulations by 2019.1 Given that the Spanish banks alone are believed to need well over €100 billion today simply to keep their capital ratios in check, it is hard to believe €370 billion will be enough protect the world’s “too-big-to-fail” banks from future crises, but it is indeed a step in the right direction.2

Initial implementation of Basel III’s capital rules was expected to come into effect on January 1, 2013, but US banking regulators issued a press release on November 9th stating that they wouldn’t meet the deadline, citing a large volume of letters (ie. complaints) received from bank participants and a “wide range of views expressed during the comment period”.3 It has also been revealed that smaller US regional banks are loath to adopt the new rules, which they view as overly complicated and potentially devastating to their bottom lines. The Independent Community Bankers of America has even requested a Basel III exemption for all banks with less than $50 billion in assets,“in order to avoid large-scale industry concentration that would curtail credit for consumers and business borrowers, especially in small communities.”4 The long-term implementation period for all Basel III measures actually extends to 2019, so the delays are not necessarily meaningful news, but they do illustrate the growing rift between the US banking cartel and its European counterpart regarding the Basel III framework. JP Morgan’s CEO Jamie Dimon is on record having referred to Basel III regulations as “un-American” for their favourable treatment of European covered bonds over US mortgage-backed securities.5 Readers may also remember when Dimon was caught yelling at Mark Carney, Canada’s (soon to be former) Central Bank Governor and head of the Financial Stability Board, during a meeting in Washington to discuss the same topic.6 More recently, Deutsche Bank’s co-chief executive Juergen Fitschen suggested that the US regulators’ delay was “hurting trans-Atlantic relations” and creating distrust... stating, “when the whole thing is called un-American, I can only say in disbelief, who can still believe in this day and age that there can be purely European or American rules.”7 Suffice it to say that Basel III implementation has not gone as smoothly as planned.

One of the more relevant aspects of Basel III for our portfolios is its treatment of gold as an asset class. Documents posted by the Bank of International Settlements (which houses the Basel Committee) and the United States FDIC have both referenced gold as a “zero percent risk-weighted item” in their proposed frameworks, which has launched spirited rumours within the gold community that Basel III may define gold as a “Tier 1” asset, along with cash and AAA-government securities.8,9 We have discovered in delving further that gold’s treatment in Basel III is far more complicated than the rumours suggest, and is still, for all intents and purposes, very much undecided. Without burdening our readers with the turgid details, it turns out that the reference to gold as a “zero-percent risk-weighted item” only relates to its treatment in specific Basel III regulation related to the liquidity of bank assets vs. its liabilities. (For a more comprehensive explanation of Basel III’s treatment of gold, please see the Appendix). But what the Basel III proposals do confirm is the regulators’ desire for banks to improve their liquidity position by holding a larger amount of “high-quality”, liquid assets in order to improve their overall solvency in the event of another crisis.

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