Federal Deposit Insurance Corporation regulators released a “rulemaking notice” of proposed changes to capital requirements for banks under their supervision. While this sounds like a relatively obscure move, which has drawn almost zero media attention, it could be the single largest event affecting gold demand since central banks became net purchasers in 2010.
Understanding the nature of this proposed change requires a basic knowledge of “risk-weighted” assets as defined by the FDIC. All banks have capital requirements that dictate that they hold a certain amount of assets with relation to the amount of money they have on deposit. This protects the integrity of the bank and its depositor’s money so that some unforeseen emergency doesn’t make the bank incapable of honoring client withdrawals.
The concept is pretty simple but the FDIC rightly holds that not all assets are created equal when it comes to their ability to fulfill capital requirements. In other words, a bank satisfying a million dollars of capital requirements by risky mortgage backed securities would be less able to withstand stresses than a bank fulfilling the same capital requirement with cash or treasury bonds. In this example the risky securities would be “risk-weighted” so the bank would have to own more of them to fulfill the same capital requirements.
So have you ever wondered why private banks hold very little gold while governments continue to buy large quantities? Capital requirements have long held that gold must be a “risk-weighted” asset. As insane as it may sound, the federal government’s capital requirement regulations currently consider Fannie May and Freddie Mac bonds to be safer investments than gold since they have received less “risk-weighting” than bullion. What this has meant is that even in times when gold has been moving strongly to the upside, banks have had a tremendous opportunity cost in owning the stuff since they couldn’t effectively use it to cover capital requirements. Clearly this makes no sense, and it looks like it is finally going to be changed. The new rule change proposal recommends that gold be given a zero risk-weight rating. That means, as far as banks are concerned, that gold will finally be…as good as gold. Here’s the text of the FDIC letter: http://www.fdic.gov/news/news/financial/2012/fil12027.pdf
So assuming this rule change is made, will gold go skyrocketing on the news? Probably not. What this will do however is drastically increase the long-term appeal of gold ownership from a banker’s standpoint. It will also add another group of major institutional players to the bullion market in times of strong gold price increases. This is the type of news that should really matter to the gold market. While all eyes are turned to the Fed trying to figure out where the markets will move in the next six hours, changes like this could have significant impacts for the next sixty years. What’s truly amazing is that nobody is talking about it.
Mike Getlin is Executive Vice President of Merit Financial, home to America's fastest growing physical gold IRA company. Please send comments or questions to email@example.com.