Why Banks Are Questioning Gold’s 0% Risk Weight and 85% Funding Penalty

Key Takeaways

• Allocated physical gold has carried a 0% risk weight in bank capital rules since 1988 — the same treatment as cash and top-rated government bonds. [LBMA, May 2025]

• Despite that capital treatment, gold is excluded from the Basel III list of High-Quality Liquid Assets (HQLA) and cannot be used to satisfy the 30-day liquidity buffers banks must hold. [Basel Committee on Banking Supervision, 2010]

• Under the Net Stable Funding Ratio (NSFR), gold is assigned an 85% Required Stable Funding (RSF) factor — the same level applied to commodities and equities. [LBMA, May 2025]

• In June 2026 the London Bullion Market Association asked the Bank of England’s Prudential Regulation Authority to address this inconsistency, citing roughly $510 billion in average daily global gold trading volume. [LBMA, June 2026]

• Regulatory change is moving toward greater recognition of gold’s liquidity. Each step that narrows the regulatory gap reduces the cost of holding gold on banks’ books and supports growing institutional demand for physical gold.

Global gold markets trade at scale — roughly $510 billion per day as of mid‑2026 — with London’s over‑the‑counter market representing a large share. Bid‑ask spreads, transaction depth, and the speed at which bars held in central vaults can be transferred all point to a very high level of practical liquidity. By operational measures, gold often behaves like a top‑tier liquid asset.

Yet bank liquidity regulations treat it differently. This mismatch between capital rules and liquidity rules is now a live regulatory issue, with direct implications for institutional demand and the structure of the gold market.

What Does “High-Quality Liquid Asset” Actually Mean?

The Liquidity Coverage Ratio (LCR), part of the Basel III framework introduced in 2010, requires banks to hold enough easily convertible assets to survive a 30‑day stress period without external support. Qualifying assets — HQLA — are those that can be converted to cash quickly and with limited loss in stressed conditions. Examples include cash, central bank reserves and high-quality government bonds.

Gold is not listed among HQLA. When the LCR rules were first published, the Basel Committee excluded gold, citing limited trading evidence and concerns about volatility at the time. Although the global market and the available data have evolved substantially since then, gold’s exclusion from the HQLA list remains in force.

How Does Basel III Treat Gold for Capital Purposes?

The inconsistency begins with capital rules. Since the original Basel Accord in 1988, allocated physical gold has been assigned a 0% risk weight for capital adequacy — the same as cash and the highest‑quality sovereign debt. The rationale is simple: allocated gold held in a vault is not a claim on a counterparty and therefore carries no issuer default risk.

That 0% capital weight has persisted through subsequent Basel revisions and remains a powerful endorsement in sovereign reserve and institutional frameworks. Yet, despite this capital treatment, the very same gold is excluded from the liquidity buffers banks must hold under Basel III.

Put plainly: for capital metrics, gold is treated like cash; for liquidity metrics, it is treated as if it were a commodity. That structural contradiction has real implications for how banks price and hold gold.

What Is Gold’s Required Stable Funding Factor Under Basel III?

The Net Stable Funding Ratio (NSFR) requires banks to fund their assets with sufficiently stable, long‑term sources. Each asset class receives a Required Stable Funding (RSF) percentage. Higher RSF means an asset is more expensive to fund over the long term.

Gold’s RSF under current rules is 85% — the same level applied to equities and many physical commodities. In practice, that means a bank holding $100 million of gold must maintain approximately $85 million of stable funding as a backstop, which raises the effective cost of carrying gold on the balance sheet.

Regulators set the 85% RSF based on a view that gold behaves like a commodity. However, mounting trading data and stress‑period performance increasingly indicate gold’s liquidity profile is much closer to that of high‑quality sovereign debt than to most commodities.

What Does the Trading Data Say About Gold’s Liquidity?

Average daily global gold trading volumes were around $510 billion through May 2026, with about $230 billion of that trading in the London OTC market. For perspective, the US Treasury market — the benchmark for sovereign liquidity — trades roughly $600–$700 billion per day. Gold is not quite at that scale but is in the same order of magnitude.

Academic and industry studies have also measured gold’s liquidity using bid‑ask spreads, trading volumes and illiquidity ratios. These analyses show gold performs like a highly tradable financial asset, often resembling sovereign bonds rather than typical commodities.

Notably, during a stress episode in late January 2026, trading volumes spiked: total market activity across venues reached record levels and OTC trading surged, demonstrating robust market functioning under stress rather than illiquidity.

What Is the LBMA Asking the Bank of England to Do?

In March 2026 the Bank of England’s Prudential Regulation Authority (PRA) published Consultation Paper CP5/26 on modernizing liquidity policy, with an emphasis on operational readiness — how quickly banks can access and monetize assets under stress. That consultation gave the LBMA an opportunity to press for a reassessment of gold’s place in liquidity frameworks.

The LBMA’s submission highlights that many PRA‑regulated firms already maintain allocated gold accounts at the Bank of England. That gold is held in central bank custody, transferable on the Bank’s books, and can be monetized quickly via OTC trades, swaps or exchange activity within the same business day. Given this operational readiness, the LBMA asks the PRA to: provide guidance on treating BoE‑held gold in internal liquidity assessments; require firms to document gold’s monetization performance under stress; and consider, over time, whether allocated gold held at the BoE should be eligible as central bank collateral.

Why Does This Matter for Physical Gold Owners?

The regulatory mismatch between capital and liquidity treatment reflects older judgments made when trading data and stress‑period evidence were more limited. Today, that evidence is substantially stronger and points toward greater operational liquidity for gold.

If regulators narrow the gap — by recognizing gold’s liquidity or by allowing BoE‑held allocated gold to count toward central bank drawing capacity — the direct cost of holding gold on bank balance sheets would fall. Lower costs would make banks more willing to hold gold as part of their liquidity buffers, increasing institutional demand. Given physical gold’s relatively fixed short‑term supply, stronger demand from banks and institutional investors would be structurally supportive of price.

The market has already shifted toward allocated physical custody since NSFR implementation, as bullion banks and clients prioritized holding specific bars in vaults. Central bank purchases have also been strong in recent years, reinforcing gold’s role in official reserves.

Is Gold Actually a High-Quality Liquid Asset?

Formally, as of June 2026, gold is not classified as a Level 1 HQLA under Basel III. Industry organizations have clarified that no official reclassification has been announced. In practice, however, empirical measures of liquidity — spreads, volumes and performance under stress — align gold closely with Level 1 characteristics.

Both the LBMA and the World Gold Council continue to engage regulators with evidence and policy proposals. The regulatory trajectory is toward greater recognition, but any formal change depends on national regulators and the PRA’s response to consultation inputs rather than an immediate global rule change.

People Also Ask

What is the difference between allocated and unallocated gold, and why does it matter for bank regulation?

Allocated gold refers to specific, identified bars held in a vault and legally owned by the client; a bank cannot re‑use those bars. Unallocated gold represents a creditor relationship: the client has a claim against the bank for a quantity of gold, but no specific bars are earmarked. Under NSFR rules, unallocated gold faces an 85% RSF burden. Allocated gold held in client accounts and stored off the bank’s balance sheet changes how the NSFR is applied and reduces funding costs, which is why the market has gravitated toward allocated custody.

If gold were officially added to the HQLA list, what would happen to demand?

Official HQLA recognition would remove a structural disincentive for banks to hold gold as part of their liquidity buffers. That would likely increase institutional holdings by lowering balance‑sheet and funding costs. The World Gold Council and industry participants argue this would meaningfully boost demand, though exact impacts depend on haircut levels and specific national implementations.

How does the Liquidity Coverage Ratio work, and where does gold fit today?

The LCR requires banks to hold HQLA sufficient to cover projected net cash outflows over a 30‑day stress period at a minimum ratio of 100%. Because gold is not HQLA, banks cannot include on‑balance‑sheet gold in that buffer. Gold held on an allocated basis at the Bank of England sits outside a commercial bank’s balance sheet and therefore does not directly affect that bank’s LCR, which is why the LBMA emphasizes BoE‑held allocated gold in its arguments.

Does silver face the same regulatory gap as gold?

Yes, silver is also excluded from the HQLA list and carries an 85% RSF under current NSFR rules. However, silver has not enjoyed a 0% capital risk weight under Basel accords, and it lacks the same sovereign custody infrastructure that underpins the LBMA’s case for gold. As a result, regulatory momentum for silver lags gold and likely depends on gold setting a precedent first.

What is Basel IV, and could it change gold’s regulatory treatment?

“Basel IV” is commonly used to describe the Basel III finalization package (sometimes labeled Basel 3.1 or the Basel III Endgame), which aims to standardize risk‑weighted asset calculations. While these reforms affect how banks calculate capital, they do not directly reclassify HQLA or NSFR treatment for gold. National regulators’ implementation choices — and consultations like the PRA’s CP5/26 — are the likeliest near‑term path for any change.

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SOURCES
1. LBMA — Response to PRA Consultation Paper CP5/26: Modernising the Liquidity Policy Framework, June 2026
2. LBMA — Gold and HQLA: Correcting Misleading Online Information, May 2025
3. World Gold Council — Gold Demand Trends Full Year 2025; Gold Demand Trends Q1 2026; Does Gold Qualify as an HQLA Under Basel III? (June 2025); Has Gold’s Performance Structurally Changed? (April 2026)
4. Bank of England — CP5/26: Modernising the Liquidity Policy Framework, March 2026
5. Bank of England — PS9/24: Implementation of the Basel 3.1 Standards, September 2024
6. Basel Committee on Banking Supervision — Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools, December 2010 / January 2013

Disclaimer: This article is for informational purposes only and does not constitute financial or investment advice. Consult a qualified financial adviser before making investment decisions.

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