Will New Banking Rules Lead to a Gold Buying Spree?

A substantial increase in demand for gold could be on the horizon if new international banking regulations are established, according to the firm run by billionaire investor Eric Sprott.

In an article published on Sprott Asset Management’s website, entitled Gold: Solution to the Banking Crisis, Sprott and his colleague David Baker discussed the potential for banks to significantly raise their gold holdings under the proposed Basel III system.

“The Basel Committee on Banking Supervision is an exclusive and somewhat mysterious entity that issues banking guidelines for the world’s largest financial institutions,” Sprott began by noting. “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.”

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Sprott subsequently discussed the implications for the yellow metal: “If the Basel Committee decides to grant gold a favourable liquidity profile under its proposed Basel III framework, it will open the door for gold to compete with cash and government bonds on bank balance sheets – and provide banks with an asset that actually has the chance to appreciate. Given that US Treasury bonds pay little to no yield today, if offered the choice between the ‘liquidity trifecta’ of cash, government bonds or gold to meet Basel III liquidity requirements, why wouldn’t a bank choose gold? From a purely ‘opportunity cost’ perspective, it makes much more sense for a bank to improve its balance sheet liquidity profile through the addition of gold than it does by holding more cash or government bonds – if the banks are given the freedom to choose.”

“If banks all bought gold as the non-Western central banks have, it is likely that they would all profit while simultaneously improving their liquidity ratios,” the firm added. “If they all acted in concert, gold could become the salvation of the banking system. (Highly unlikely… but just a thought).”

Sprott went on to say that “If global banks’ are realistically going to improve their balance sheet diversification and liquidity profiles, gold will have to be part of that process. It is ludicrous to expect the global banking system to regain a sure footing through the increased ownership of government securities.”