New net stable fund ratios may have dire impact on the gold industry, sources say

The gold industry could be in for a wake-up call, and further liquidity squeeze, when potential new net stable fund requirements are passed at the start of 2018, sources close to the situation have been telling S&P Global Platts.

Although the potential rejig of legislation -- being pushed by the European Commission -- relating to how funding requirements of the gold leasing model is more than a year away, that isn't stopping high level industry participants from lobbying against what could end up damaging the entire business from mine supply to end users, Platts has learned.

New funding requirements, that in essence will add financial burden to the way banks structure gold leasing, or loans as more commonly known, will without doubt see financial institutions forced to increase the interest charged to cover their own inflated cost of carry trade, according to sources.

The 'net stable funding ratio' -- or NSFR -- of 85%, timetabled for launch January 2018, could make short-dated credit agreements impossible. According to bankers this will mean having to pass the costs onto its customers across the value chain, or exit entirely.

"We're certainly not in a position to absorb the addition," said one senior banker.

Bankers are working on ways to minimize exposure, with two bankers estimating a ballpark figure of $20-80 million being added to balance sheets annually. As the new ruling is not yet active, all of these equations are based on assumption leaning towards worst case scenarios.

The bullion business is already under immense cost pressure, piled on by mounting regulation, and as such is mindful of the impact that further hikes could have -- primarily on liquidity -- something that is already rapidly evaporating, sources have told Platts, evident in more and more banks exiting the business.

Partnerships

Industry body the London Bullion Market Association is working alongside other representatives including the World Gold Council and London Platinum and Palladium Market to lobby various bureaucrats in order to starve off the intended increase of fund ratio needed to finance leasing.

In simple terms bullion banks supply refined gold bullion to refiners in order for them to secure offload of dore (a semi-finished gold/silver alloy) to then in turn process into refined metal and pay back the original loan.

One letter signed by a handful of industry organizations said the lease process is an integral part of the bullion industry due to the high cost "and need to borrow short term." The loans also "protects the refiner from any adverse price movements" and without them the refiner would be completely exposed to the price and would have to fund the entire process itself.

"Sufficient availability and reasonable pricing of gold loans are therefore critical to the industry," the letter added.

The new NSFR requirements will mean that the cost of lending the metal will balloon and create a possible liquidity squeeze. It's clear that the increase is causing headaches for those involved.

The requirements are believed by policy makers to act as a security net for the business but could in fact have the complete opposite effect over time.

With more and more participants already exiting, increased monetary pressure could lead to others stepping away; adding another element of deceased liquidity.

The second document seen by Platts sent to the European Commission by the WGC and LBMA cautioned that if banks leave the party it could see "trading and lending activity being pushed unto unregulated shadow banking sectors or back onto balance sheets of banks' counterparties."

There is also some talk that the business could move into the hands of large unregulated trading houses.

However, one physical gold trader at one of the biggest operations recently told Platts that he has no interest in taking over the responsibility, as the unit is simply not integral enough to the wider business.

Not just refiners; miners, too

Most of the attention for now has been on how this will dent the refiners margins, however if fabricators struggle to secure favorable terms with the banks it in turn will have a knock on effect to the producers.

One senior bullion banker said that ultimately it will be the miners that are hard hit, forced to hold on to metal or look for new ways in which to fund inventory.

A "doomsday" scenario could see miners having to fund themselves without seeing payment until the gold is sold at the retail level. Fair enough, this is a worst case scenario, but by no means a figment of someone's imagination.

When gold is referred to as cash that is generally at the banking level. Banks own the metal and use it as collateral for leasing and creating flow across the chain. The second document pointed out that, "the industry as a whole treats gold as a currency."

The senior banker cautioned that: "New requirements will mean we have to start taking on new risk, something that is meant to be being reduced."