Impact of Basel III on the Gold Price

The full implications of the changes in Basel III on the gold industry is still much debated. If the rules are fully implemented banks are likely to reduce the size of their gold and silver businesses. The potential liquidity effects of the new rules on the gold and silver market could be significant – and cascade to all investors. Institutional investors are less likely to participate in the precious metals space if the market is less liquid and mining companies could see reduced funding and higher costs for funding. The LBMA and World Gold Council have said that the new rules “fail to take into account the damaging effect that the rules will have on the precious metals clearing and settlement system, potentially undermining the system completely, and on the increased costs of financing of precious metals production.”


Under Basel III a banks gold holdings now fall into two groups – allocated gold (physical gold) and unallocated gold (also called paper or contract gold). The difference between allocated and unallocated gold is important. Allocated gold is physical gold that is sitting in a vault and is owned directly by the customer. Unallocated gold (also called paper or contract gold) isn’t physically stored for the customer by the bank. The gold remains the property of the bank, and the customer becomes a creditor of the bank or gold dealer. The new rules are to prevent banks from having more than one owner for the unallocated gold or from stating that it has gold but does not actually hold the physical gold.


Unallocated gold is not being reclassified as Tier 1 capital but will remain part of Tier 3, under Basel III banks will now have to hold extra collateral against it. This is because Basel III includes the new Net Stable Funding Ratio requirement, which, as it relates to gold, states that the value of unallocated gold has to be collateralized by a margin of 85% with Tier 1 assets (this is the same ratio as equities held by a bank). Since this requirement did not exist before Basel III this means that it is much more expensive to hold unallocated gold, which in turn will mean higher fees for customers.


The Basel III rules went into effect in some European Banks as of June 28, but the real question is what will be the effect if the rule is implemented on all the banks in Europe and especially the impact on British banks where US$200 billion in unallocated gold is traded on a daily basis. (British regulators have stated that banks clearing gold trades can apply for an exemption to the Basel III rules that are scheduled to take effect in the UK January 1, 2022.)

According to the LBMA, banks have preferred dealing in unallocated gold because of its convenience, it was an inexpensive way for professional counterparts to trade without having to move physical gold bars each trade. Most of the 20 million ounces of gold that is traded daily through the LBMA is unallocated gold. This means that not only do banks have to increase their Tier I reserves to cover 85% of their current unallocated gold contracts but will also have to continue increasing Tier I if the value of their unallocated gold contracts increase.

A joint LBMA-WC letter to the Prudential Regulatory Authority set out concerns about the new rules under Basel III (and in particular about the Net Stable Funding Ratio and the 85% Required Stable Funding (RSF). The concerns included that the current clearing and settlement system would be undermined, and could even force some participants to exit the clearing and settlement system due to the higher costs. This in turn would drain liquidity, increase financing costs dramatically to all participants including miners, manufacturers, and non-bank participants. This would also affect central banks operations as central bank deposit, lending and swaps in precious metals are essential to offset costs of storing gold reserves and in generating income.


The LBMA and World Gold Council have proposed solutions, such as exempting clearing and settling transactions from the ratio rules, and as stated above British bank regulators already look to be exempting banks clearing gold transactions from the rules.