gold becomes a tier 1 asset class for banks, page-7

Hi there Hercules

Banks have accounting environments that are strictly segregated:
1. Accrual Accounting
2. Mark-to-Market
The capital requirements for transactions booked in these segregated accounts are very different.

Currently most banks book gold positions in trading books (along with bonds and swaps and other positions that are held on a short term basis.) The capital requirements for these deals are low on the condition that they don't stay on the books for very long. There are two conditions for holding assets in a trading book:
1. The change in market value of the position is brought to account daily (Mark-to-Market); and
2. The bank has to hold some capital to cover adverse movement in that mark-to-market value. This is calculated by Value at Risk (VaR) in most banks.

By doing these, banks have a buffer to cover losses on market shifts for these positions.

The capital requirements for holding asset in the Accrual Accounting banking books are much more onerous.
Under Basel I a bank is required to hold $8 of capital for every $100 loan (asset)!

By making gold a zero risk weighted asset, no capital would be required to support gold held in the banking book. This assumes that gold is risk free.

This isn't true.

We know that the price of gold goes down as well as up, and it is possible for a bank to lose money holding gold, and when that money is lost, capital is destroyed equal to the value of that loss. It would possible for weakness in the POG to cause a bank to breach it's Basel Capital requirements, or even become insolvent in an extreme scenario.

Cheers