Basel III, which is designed to reduce the risk of a run on the banks came into force, June 28.
The Basel Accords’ recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision are yet another major event flying under the radar of mainstream business media.
Basel III should make business news, bearing in mind it is the third Basel Accord has a significant impact on banking liquidity, Maco economics, monetary policy, and the price of gold.
“Basel III, which is designed to reduce the risk of a run on the banks came into force, June 28”
Let’s zero in on Basel III, starting at basement level with a definition
Basel III, the third installment of the Basel Accords was drafted in response to the shortfalls in financial regulation revealed by the financial crisis of 2007–08 and climaxing with Lehman Brothers bankruptcy in September 2008.
Basel III is a global, voluntary regulatory framework that stress tests banks against financial-economic shocks
By introducing requirements on liquid asset holdings and funding stability, on bank capital adequacy.
Basel III, in a few words, is an international agreement requiring banks to increase the bank’s minimum capital ratios, which is intended to raise the integrity, trust, and stability of the financial system.
What is the mechanics of Basel III?
As explained above the Basel Accords raise the bank’s minimum capital ratios by introducing requirements that increase Tier 1 Capital.
Common Equity Tier 1 (CET1) include liquid assets such as cash, prime sovereign bonds, gold, and stock (not common equity). So CET1 is a measurement of the bank’s liquidity, which typically comes under stress in a crisis.
“Basel III, is an international agreement requiring banks to increase the bank’s minimum capital ratios, which is intended to raise the integrity, trust, and stability of the financial system”
The idea of the Basel Accords is to gradually increase CET1 without creating a liquidity squeeze and choking the economy.
For example, The original Basel III rule from 2010 required banks to fund themselves with 4.5% of Common Equity Tier 1 (CET1) (up from 2% in Basel II).
Moreover, since 2015, a minimum CET1 ratio of 4.5% must be maintained at all times by the bank.
In July 2013, The US Federal Reserve raised the CET1 minimum Basel III CET1 ratio to 6% for 8 systemically important financial institutions (SIFI) banks and 5% for their insured bank holding companies.
In the EU banks have been required to disclose their leverage ratio since 2015, but a binding requirement has not yet been implemented. The UK operates its leverage ratio regime, with a binding minimum requirement for banks with deposits greater than £50bn of 3.25%.
high-quality liquid assets to cover its total net cash outflows over 30 days under a stressed scenario.
Gold, classified as Tier high-quality liquid asset.
“Basel III also could have an impact on monetary policy”
– Win Investing
What is the impact of Basel III?
Raising the banks’ liquidity CET1 ratio increases the banks’ capital requirements, which the banks then pass on in the form of higher banking costs to their customers. So, to meet the Base III CET1 of 4.5%, an increase of 2% banks effectively increases their lending spreads.
Put another way, Base III is a potential headwind on the global economy because it diverts liquidity away from lending for economic expansion to CET1, SO fewer liquidity loans are being made for economic expansion.
An OECD study, released on 17 February 2011, estimated that the medium-term impact of Basel III implementation on GDP growth would be in the range of −0.05% to −0.15% per year.
Basel III also could have an impact on monetary policy
If raising the banks CET1 is a headwind on economic activity and liquidity, then one logical conclusion is that monetary policy easing could continue to be implemented for longer to counterbalance the impact of Basel 111.
If so, this supports the view that the Fed’s expressed intention of pending dot plot rate rise in 2023 would seem less likely in the wake of Basel III raising of bank liquidity requirements.
Moreover, the likelihood Fed tapering of its quantitative easing QE 120 billion dollars of asset purchases a month, which entail holding of treasury holding by at least 80B per month and agency back securities by at least 40B per month also seems less likely in the wake of Basel III.
“ultimately the new rules will make it more costly for banks to hold unallocated gold accounts” – Vijay Valecha
If Basel III results in the Fed extending emergency monetary policy, which has been implemented since 2008, what impact is that likely to have on asset prices?
As written in a piece, entitled Bullish For Gold and The Reflation Trade, dated June 17 Darren Winters wrote Skyrocketing Money supply M2 will continue, which is likely to be bullish for gold and reflation trade.
He noted that it is a contrarian view at the time, bearing in mind mainstream news and analysts misinterpreted the Fed last meeting on rates as hawkish, despite the Fed making no changes to its $120B of asset purchases per month and talking about a dot plot rate hike in 2023!
In light of Basel III, we are even more bullish on assets that are not correlated to the ballooning public G7 public deficits
We believe that an aging population and declining worker participation rates not seen since the 70s in the US could lead to UBI resulting in an even larger public deficit. Declining worker participation rates in advanced economies could be a macro trend accelerated by automation and the digitalization of the economy.
So, we remain even more bullish on gold and cryptocurrencies, particularly ETH, the main secure blockchain network facilitating the booming digital ecosystem from DeFi to Web 3.0.
But Basel III could be the catalyst that triggers a bull run in gold, bearing in mind that treasury yields can’t rise with so much debt in the system
“Ultimately the new rules will make it more costly for banks to hold unallocated gold accounts. So, the response could go one of two ways: Either bank will raise their costs to investors for unallocated gold, which will lower gold demand and hurt prices” said Vijay Valecha, chief investment officer at Century Financial.
“Or banks would focus more on offering allocated gold accounts, creating a scramble for more physical gold bullion.
The resulting liquidity squeeze would push gold prices much higher
Indeed, in the 1970s, gold rose from a low of US$35 per ounce in 1971 to a peak of US$180 in late 1974.So, the crux of Basel III is that gold could be the most underpriced asset available today, bearing in mind the system is so heavily in debt that its unable to shoulder higher yields or rate hikes.
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