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Basel III: How fintech can provide allocated gold for banks

Banking rules that were over 10 years in the making as a response to the financial crisis have finally come into effect, marking a seismic shift for European banks and their dealings with gold – potentially completely altering the landscape of precious metal investment. Sylvia Carrasco, CEO of Goldex, explains

As a consequence of the global crash in 2007-2009, the Basel Committee on Banking Supervision, which creates standards for bank regulation, developed what is known as Basel III. This is an internationally agreed set of measures that aim to strengthen regulation, supervision and risk management. Essentially, it tries to ensure that banks are better equipped to withstand economic shocks by requiring them to hold more stable assets and fewer riskier ones.

There are three main points to Basel III: banks must hold increased capital; they must maintain a minimum leverage ratio above 3%; and they also face higher liquidity requirements.

Under the new rules, physical gold (also known as allocated) such as bars and coins are being reclassified from Tier 3 – the riskiest asset class – to Tier 1, which means it is now defined as zero-risk. Because of this, central banks can now value their gold at 100% of its value, but only if their gold is physical and provable.

This physical-gold requirement for Basel III has enormous implications for commercial banks, bullion dealers and other firms that trade in any form of “unallocated” gold. Understanding the difference between allocated and unallocated gold is crucial here: allocated gold is gold owned outright by an investor and is stored, under a safekeeping or custody arrangement, in a professional bullion vault.

When buying unallocated gold, however, you become the creditor – the bank owes you gold you do not own. Although this removes the need to pay for insurance or physical storage, you are still investing in gold under the assumption that the bank will honour its side of the agreement in the event of a catastrophe – such as bankruptcy, insolvency or another financial collapse.

And as the crisis proved, banks do not always hold their side of the bargain in times of economic distress. This is what Basel III is trying to prevent.

Unallocated gold is the most widely traded form of gold in the world and is thought to take up to 95% of gold business – in London alone, the amount traded daily is worth about $200bn– but the new Basel III regime means that banks are required to put up 85% of the value of unallocated gold in cash. Before Basel III, it was 0%.

The ramifications of these changes are huge. They mean that the entire trading, clearing, financing and settlement infrastructure of unallocated gold becomes exponentially more expensive. Unallocated gold, or “paper” gold, is classified as more risky than physical gold, and no longer counts as an asset like bars or coins. Subsequently, some bullion providers and other institutions may have to stop offering unallocated gold and close these parts of their businesses.

Liquidity issues

Less unallocated gold is also likely to cause liquidity issues: the high cost of offering it forces many dealers out of the market, so supply drops. The focus of gold trading then shifts to allocated gold, which could result in increased demand that squeezes liquidity and potentially sends gold prices soaring in value – after all, there is only a finite amount of gold around the globe.

With EU regulations forcing banks to offer better and fairer access to gold investment, the emphasis on investing moves towards physical ownership of the precious metal instead of exposure to its prices. 

This is where fintech can step in to help address the new regulations and transform an antiquated gold industry that has been one of the last disrupted sectors in finance, lagging behind other forms of investing for years.

Banks and gold providers that want to offer allocated gold will need to find a solution that offers both competitive pricing and multiple sources of significant liquidity.

So, with a higher demand on allocated gold, fintech is well placed to provide access to multiple liquidity venues and best-price discovery tools. Through developing plug-and-play connections over API or fixed information exchange (FIX), institutions can offer their customers access to best pricing on physical gold 24 hours a day, seven days a week. 

Emerging marketplace technology means businesses don’t have to rely on a single supplier and buyers can enjoy full legal title over their gold, secure in the knowledge that vaulting has been taken care of. With banks’ over-reliance on unallocated gold, the service can be launched and deployed in a matter of weeks, making it a cost-effective solution to shifting regulatory requirements.

Eventually, unallocated gold could disappear entirely and in the event of another global crisis, the investors and companies that have purchased physical gold – or the ones that can provide access to direct ownership of the precious metal – will be the ones to benefit the most.

Sylvia Carrasco is the founder and CEO of Goldex , a fintech launched in 2018 to unlock the world of allocated physical gold investments for all. Read more about Goldex here.

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