Perhaps you have never heard of the Bank for International Settlements (BIS) located in Basel, Switzerland. Perhaps you have never heard of the Basel Committee on Banking Supervision (BCBS), a separate legal entity with headquarters at the BIS. But these two regulatory bodies play a considerably important role in the development of international banking supervisory standards. And, as it happens, they also put forward propositions on how gold is to be seen by the banks.
The BIS was set up in 1930, its goals and means have changed throughout the years and today its main scope of activity is to provide central banks with credit when necessary and to help in achieving monetary and financial stability on an international level. The BCBS was established in 1974 and is primarily concerned with coordinating banking supervisory activities. Both BIS and BCBS are organizations with history but neither of them have legal power to enforce any changes in the law of its members.
On the other hand, it proves that the BCBS has considerable influence among central banks all over the world. In 1988 the Committee outlined what is currently known as Basel I — a set of recommendations on capital requirements. Long story short, bank assets were divided into several groups based on their perceived riskiness (bonds and gold were in the least risky category) and banks were required to cover 8% of their assets according to a special formula. The intuition was that at least a part of all the assets of the banks should be backed up by assets perceived as “safe” (including gold). Even though the BSCB did not have any regulatory power, its members adhered to its requirements, with the level of adherence varying among the countries.
In 2004, Basel II was introduced with more detailed recommendations on capital requirements, banking supervision and market risk. Bank assets were divided into three categories where Tier 1 encompassed assets perceived as least “risky” and Tier 3 comprised of assets perceived as “risky.” The recommendations were amended multiple times; however, they failed to adequately identify the risks associated with structured credit products, like mortgage-backed securities. These risks were severely underestimated or even not identified. As far as gold is concerned, under Basel II it was treated as either Tier 1 or Tier 3 capital, since the BCBS stipulated that:
(…) at national discretion, gold bullion held in own vaults or on an allocated basis to the extent backed by bullion liabilities can be treated as cash and therefore risk-weighted at 0%.
Now, let’s make this absolutely clear, this excerpt comes from the Basel II (!) documentation and NOT from the Basel III one. So, depending on the decision of the country gold was either counted as Tier 1 or Tier 3 capital already under Basel II. Gold was also accepted as collateral with a supervisory haircut of 15%.