Target 2 balances: Indicator of the intensity of the European debt crisis
The Target2 balances of central banks in the Eurosystem rose substantially in 2011. These balances reflect the capital outflows from vulnerable eurozone countries and are, therefore, an important indicator of the intensity of the European debt crisis. The Target2 balances will decrease once the vulnerable countries and their banks regain market access. This, however, will require European governments to take effective action to resolve the underlying problems.
Target2 balances reflect debt positions within the Eurosystem
Target2 is the payment system enabling direct transfers between commercial banks in the eurozone. These transfers can arise from many different sources, including trade transactions and interbank loans. Target2 payments are channelled via accounts that banks hold at their national central bank (‘NCB’). If the banks in a particular euro country are net receivers of cross-border payments via Target2, this results in that country’s NCB having a claim on the ECB, which acts as the central counterparty within the Eurosystem. The NCB in a euro country with a net payment outflow will have a liability to the ECB. The accounting entries representing the amounts that NCBs owe to or are owed by the ECB are referred to as ‘Target2 balances’.
Europe an debt crisis has resulted in substantial rise in Target2 balances
As the following chart shows, Target2 balances have risen substantially since the start of the banking crisis, and particularly as a result of the debt crisis.
The loss of confidence in vulnerable countries and their banks has resulted in a net capital outflow to banks in countries such as the Netherlands and Germany, whose creditworthiness is perceived to be higher. The drying-up of the interbank money market has certainly contributed to this. Banks in vulnerable countries have fund ed this net outflow by borrowing more from the Eurosystem, which since October 2008 has been providing unlimited credit to banks able to provide sufficient eligible collateral. Following the escalation of the debt crisis in the second half of 2011 the Eurosystem even started providing three-year loans (see for more information). The Eurosystem has introduced these exceptional emergency measures so as to avoid liquidity problems forcing banks to drastically reduce their lending to businesses and households. This is because a ‘credit crunch’ would cause great damage to the economies of vulnerable countries and possibly result in deflation.
A Target2 claim does not reflect the risk in the monetary policy credit operations
The Target2 claims of DNB or the Bundesbank do not reflect the risks to which these central banks are exposed as a consequence of the monetary policy credit operations by the Eurosystem. Credit outstanding in these operations has strongly increased as a result of the crisis. If, despite the collateral provided, a bank’s insolvency were to result in the Eurosystem suffering losses on monetary policy credit operations, these losses will be divided among the NCBs pro rata to their share in the capital of the ECB. DNB has contributed 5.6% of the ECB’s capital. In the hypothetical case of a country deciding to leave the EMU and prohibiting its central bank from meeting its obligations to the ECB, the resultant losses would also be divided among the remaining NCBs pro rata to their capital subscription. Of course, the relative capital subscriptions of the remaining NCBs would then have to be adjusted accordingly. Losses suffered by NCBs are not determined by their Target2 positions, however. In the extreme and highly unlikely scenario of several countries leaving the EMU, the risks for the remaining NCBs would increase correspondingly as any losses would then have to be shared by fewer NCBs.
An effective solution to the debt crisis needed to normalize Target2 balances
The Target2 balances will decrease once the vulnerable countries and their banks regain market access. The surplus liquidity in the most creditworthy countries’ banking systems will then once again flow via the interbank money market to the banks in need of liquidity, thus enabling the Eurosystem to end its emergency measures. This, however, will require European governments to take effective action to resolve the debt crisis. Vulnerable countries will need to get their government finances in order and strengthen their ability to grow and compete. At the same time they will also need to strengthen their banking systems, whether with the aid of the enlarged European emergency fund or otherwise, by recapitalising viable banks and resolving banks not considered viable. The Eurosystem’s emergency measures to date have simply bought some time, but do not remove the need for the measures referred to above.
