Banking Regulators have started showing their preference for Gold. Basel III regulations have started classifying Gold as an asset class which attracts zero risk and will be valued at 100% of the value. Whereas as the paper gold will be valued at 85% of its value.  There is a shift and an indication that Central Banks are recognizing the intrinsic value of the yellow metal and discouraging the paper gold. Central Banks embrace of Gold will set the price higher and may drive the reset in the Global Bullion Markets.  Chinese and Russian Central banks in the past have been accumulating vast quantities of Gold.

Basel III reforms are directed to improve banking sector’s ability to absorb financial and economic stress, whilst focusing on improving Risk Management and strengthening disclosures. Recently the paper published by Bank for International Settlement (BIS) acknowledges the fact that still there are fault lines in the financial systems that poses risk to Global Financial Stability and adoption of Basel III, will address the challenges and may go a long way in restoring confidence in Risk Weighted Capital disclosure Framework.

Strength of financial institutions depends on its ability to survive the stress. Banks that were well capitalised were in better position to absorb the economic impact caused by Covid 19 pandemic, in comparison to Banks not adequately capitalised. In the coming future there may be bigger risk events that may lead to global disruption or a hit on the Global financial stability. Though no amount of Capital is truly sufficient, still Banks need to have culture of high-quality risk management practices build around its Balance Sheet, for navigating the crises.  During the pandemic, well capitalised banks, having high quality capital, better served the society. 

During Pandemic all of the Global Financial Institutions survived the crises which portrays the resilience of the international banking system. While governments and central banks supported the economy through monetary and fiscal measures, major banks did not needed infusion of public funds.

Basel III reforms were finalised in 2017 and has been agreed to be Globally implemented by 1st January 2023. Financial Stability is not a domestic affair. It has a Global ramification due to Global linkages of Financial Systems. Post Global Financial Crises, Policy Setters are trying to align the accounting risk disclosures in line with the business risk embedded in the Balance Sheet, and for enabling better decision making by the stakeholders.    IFRS 9 on financial instruments, mandated by the International Accounting Standards Board (IASB) provides for provisioning of losses on Expected Credit Loss approach. This is a significant departure from the past practice as it compels the Financial Institutions to recognise losses on expected basis and not or real basis. These reserves will act as a loss absorbing cushion in times of real losses and avoid surprises.

Allocation of Gold as a risk-free asset is driven by a reason as it mitigates the Counterparty credit risk as there is specific title for ownership. In case of paper Gold, multiple entities represent claim on the same ounce of the Gold. Paper Gold can be leased or swapped multiple times, in a way that same ounce is represented as asset in multiple balance sheet. These reforms are designed to strengthen the Balance Sheet and reduce systemic risk in the financial systems.  BASAL III recognizes that paper gold poses systemic risk to financial stability as it carries huge counter party credit risk. In times to come prices of the Gold will rise as sovereign currencies are losing purchasing power.

Bureau Galactik Views