Enhancing Indian commercial bank liquidity buffer with gold

Abstract

Gold research in India is still in its nascent stages. Moreover, given the instability facing the Indian Commercial Banking sector primarily due to bad debt and NPAs, we need to look for ways which can help reduce the volatility of bank portfolios and make the sector more resilient to shocks. The theoretical aspects of liquidity management are introduced, and the implications of Basel III norms are studied, a detailed analysis of the suitability of Gold as a High-Quality Liquid Asset is examined. The research involves around testing the characteristics of Gold against a set of Litmus Test parameters. The analysis suggests that Gold has lower volatility than most other risky assets except government bonds. Moreover, it has flight to quality status and low credit risk, which makes it have a positive skew in times of stress. Next, an event study is done to examine the performance of Gold against Sensex, 10 yr. government Bonds and Silver over 2005-14. The results suggest that Gold emerges as an excellent tail risk hedge, outperforming all other asset classes during 2008 crisis. Finally, an optimal portfolio is constructed and back tested in 2008 financial crisis to establish that it inclusion of Gold will enhance the liquidity buffer of commercial banks. Finally, in Chapter III, a monetization micro-structure is proposed to help develop an active secondary market in Gold in India, to help mobilize gold savings through active roles of banks and jewellers and finally, coming up with innovative products to attract more market participants.