Tier 1 capital is the core measure of a bank’s financial strength from a regulator’s point of view. It is made up of core capital, primarily common stock and disclosed reserves (or retained earnings), but also non-redeemable non-cumulative preferred stock. Banks have used innovative instruments over the years to generate Tier 1 capital; these are subject to stringent conditions and are limited to a maximum of 15% of total Tier 1 capital.
The Basel Committee for Bank Supervision, the maker of global capital requirements and whose Basel III rules form the basis for global bank regulation, is studying making gold a bank capital Tier 1 asset.
“Gold has historically been classified as a Tier 3 asset. When determining how much money a bank can loan, the bank’s gold holdings have traditionally been discounted 50% of the current market value. With value cut in half, banks have little incentive to hold gold as an asset,” says Frank Holmes of usfunds.com
If gold becomes a Tier 1 capital asset, banks could operate with far less equity capital than is currently required. Gold would be the new backstop for debt, currencies and bank equity capital.
“Anyone who understands gold’s historic role will grasp the importance of the argument behind extra bank leverage,” said Alasdair Macleod of resourceinvestor.com. He noted that direct ownership of bullion is preferable to holding fiat currency. Bullion ownership should increase confidence in any bank and the system as a whole. Bank purchases of bullion will drive up the value of gold as Tier 1 capital relative to other qualifying assets, increasing its desirability for regulatory purposes.
If gold is approved as Tier 1 capital, it will fuel demand for physical bullion and be an important step toward gold’s re-monetization. As a Tier 1 asset, gold would be competing as a safe-haven investment against unbacked bonds yielding less than zero in inflation-adjusted terms and issued by over indebted governments.
Gold is set to become the new “good collateral.” It is unique, the only non-Tier 1 asset to be universally regarded by investors the world over as a flight-to-safety asset. These considerations should be on everyone’s radar.
To read Richard Mills article: When Gold Becomes Tier 1 Capital
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