Target2 imbalances show cumulative net payment flows within the euro area
Target2 is the settlement system for euro payment flows between banks in the euro area. These payment flows are driven by trade or financial transactions such as deposit transfers, sales of financial assets or debt repayments. When the banking system in one member country has more payment outflows than inflows, its national central bank (NCB) accrues a Target2 liability vis-à-vis the European Central Bank (ECB). By contrast, if the banking system faces more inflows than outflows, the respective NCB accrues a Target2 claim. Target2 balances therefore show the cumulative net payment flows within the euro area.
Target2 imbalances were indicative of bank funding stress
Target2 imbalances rose substantially during the European debt crisis (see Figure 1). These imbalances were triggered by a loss of confidence in banks in vulnerable euro area countries and doubts about the sustainability of the Economic and Monetary Union. This provoked capital outflows from vulnerable countries to countries such as Germany and the Netherlands (see also the DNBulletin issued in April 2012). Target2 imbalances were the counterpart of these outflows and thereby indicative of banks’ funding stress in vulnerable countries. To finance the capital outflows, these banks increased their recourse to Eurosystem facilities. The liquidity provision by the Eurosystem was therefore demand-driven. At that time, Target2 imbalances were regarded as one of the most important indicators of the depth of the European debt crisis.
Figure 1 - The evolution of Target2 balances since 2008