US case study: Enhancing commercial bank liquidity buffers with gold

Published 4th April 2012

Categories: Investment, Central banks/official inst.

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As part of gold's growing financial usage the World Gold Council conducted a case study to examine gold's potential role on bank balance sheets as part of new liquidity buffers being discussed in global banking regulations within Basel III. The following case study examines the effect of adding gold to the Basel III Liquidity Coverage Ratio (LCR) and finds that, by including gold as an eligible asset in bank liquidity buffers, commercial banks would reduce the volatility of their LCR portfolios, reduce the value-at-risk of their portfolios, and improve their risk-adjusted returns.

This analysis demonstrates that by including gold as an eligible asset in bank liquidity buffers, commercial banks would reduce the volatility of their LCR portfolios, reduce the value-at-risk of their portfolios, and improve their risk-adjusted returns. The study also found that a portfolio with gold outperformed a portfolio without gold during the most extreme liquidity stress events over the past 10 years. Finally, the case study demonstrates that gold, on average, provided positive returns during credit events experienced by Bank Holding Companies and on days when bank equity indices declined significantly. 

Specifically the analysis used conservative assumptions and a statistical approach of resampling to determine the optimal liquidity buffer composition with gold and excluding gold. Back testing the results from 1994, the case study provides the following observations: 

  1. A commercial bank that held gold in its liquidity portfolio since 1994 would have witnessed less annualised volatility of 3.17% versus 3.55%, than a liquidity buffer without gold.
  2. The liquidity buffer with gold had a lower estimated VaR of a maximum loss of US$10.7mn on a portfolio of US$1.0bn with a 99% con dence level, versus US$12.9mn in a portfolio without gold.
  3. The liquidity buffer portfolio with gold increased in every liquidity stress event over the past 10 years and outperformed the non-gold portfolio by an average of 24 basis points.
  4. Gold on average outperformed US Treasuries and Agencies during Bank Holding Company credit events by as much as 33 basis points.
  5. When the Dow Jones US Select Regional Bank index or the XLF Financial Sector ETF declined by more than two standard deviations,