http://www.voxeu.org/index.php?q=node/7884
Eurosystem TARGET balance deviations call for cautious changing of the EU banking landscape
Ossi Leppänen
18 April 2012 |
Since the start of the crisis the Eurosystem balance sheet has grown from €1200 billion in June 2007 to around €2900 billion in March 2012. But this is spread unevenly among different central banks within the Eurozone, raising the thorny issue of intra-area (TARGET) balances. This column argues that these balances signal a need for change and restructuring in the Eurozone banking sector.
In the monetary policy analysis only the consolidated balance sheet of the Eurosystem is relevant. In a decentralised central banking system individual national central banks’ balance sheets are relevant when assessing banks’ short-term financing needs vis-à-vis each of the national central banks. Apart from this, the decentralised system also opens the tricky issue of intra-area (TARGET) balances.
The issue has caused an intense debate in many forums (see for instance Buiter et al 2011, Jobst 2011, Tornell and Westermann 2011, and Whelan 2011 on this site). How to interpret these balances? Have the deviations gone too far? What are the underlying causes for deviations? Should some policy changes be made or should some quick fixes applied to cover the deviations? This note discusses some policy options, especially in case the deviations threaten to become more or less permanent.
Liquidity movements and central banks’ intra-area TARGET balances
The Eurozone central banks manage the TARGET system, which is an online real-time payments settlement system of the Eurosystem. According to the balance-of-payment terminology the system registers current-account transactions as well as the balancing financial account transactions. Thus, the Eurosystem decentralised financing operations and the TARGET settlement systems replace the need to use currency reserves as the final balancing source for the balance of payments inside a currency union. The settlement system is a central arrangement in the Eurozone and is not a source of troubles as such. On the other hand, if large and permanent balance deviations in the intra-area accounts do occur and prevail for a longer period, they indicate important market tensions that need to be analysed and cautiously corrected.
Before 2007 the TARGET balances were well within a narrow €100 billion range. The deviations caused by the cross-border flows were mainly balanced through interbank transfers without difficulties. A significant change happened during the 2008, however, and again towards the end of 2011. The change was due not so much to national level current-account differences between the EU countries but rather to problems stemming from financial items; partly from difficulties in banks’ own funding and partly from changing funding practices inside the EU banking sector.
Especially in stressed situations the Eurozone banks’ shorter-term funding from private sources and partly also deposits tend to have only one direction: from banks in the countries under stress to banks in the so-called core Eurozone countries or even outside the Eurozone. This has resulted in a subsequent uneven distribution of central bank financing and also in TARGET deviations. If the underlying trend cannot be reversed there may be an awkward situation looming where much of the shorter-term funding and deposits have become concentrated in some banks while the assets and loans have not moved but mainly stayed in other banks – a situation that cannot be stable.
The role of interbank markets
In March 2012 the TARGET liabilities of the ‘periphery’ central banks to the Eurozone ‘core’ central banks through the ECB account were in the region of €800 billion. This was, however, somewhat less than the periphery-country financial institutions’ borrowing from the periphery-country central banks and also somewhat less than the core-country financial institutions’ deposits in the core-country central banks. As far as the sheer volumes are concerned one can then easily see that if the interbank markets had worked properly, the borrowed and deposited amounts in the respective central banks could have gone down and the TARGET balance deviations could also have vanished.
We must also recognise that the TARGET deviations can be balanced in different ways. A properly functioning interbank market is the first natural alternative, but it requires full credibility and trust among banks. The other more permanent alternative would be to transfer assets and loan packages from ailing banks to more stable banks with full market-value compensation. For this type of transfers to succeed it would require appropriate trading platforms or resolution mechanisms that do not exist in the EU today. Thirdly, one must also note that administrated bank liquidations would also align the TARGET balances but this would only come at some expense to central banks’ profits through the loss-sharing arrangements between the Eurozone central banks.
What if the underlying funding and TARGET deviations keep on accumulating?
The question is how to make the alignment process function again, how to restore credibility, and how to make the interbank markets (or administrated remedial measures) work properly. The longer the funding bias continues the more central bank funding is needed. The ECB’s three-year longer-term refinancing operation (LTRO) funding will temporarily alleviate banks’ funding situation but is not a lasting solution. The risk is that the public-sector responsibilities will be exacerbated if both the funding and capital become dependent on public-sector back-ups.
The need for banking sector restructuring
If large dislocations on banks’ shorter-term funding and in TARGET balances become a permanent feature in the Eurozone, this signals a need for structural changes in the Eurozone banking sector. Permanent funding biases can be corrected if banks and the banking sectors, especially in the so-called periphery countries, can deleverage and also cautiously shrink in the longer run. In addition, administrated transfers of bank assets and loan packages from struggling banks to more stable banks would do the same, representing a sort of permanent interbank transfer. Whichever method is used, if the changes are market-led or can happen over time in a managed way this would not threaten the flow of credit to the whole Eurozone. Persistent deviations in the TARGET balances roughly indicate the amount of restructuring needed in the Eurozone banking sector. If, however, structural changes and restructurings are not allowed to happen, the troubled banks will undoubtedly need continued central bank and/or other public-sector support.
The other proposals either to limit TARGET deviations or to settle balances with real asset transfers between central banks do not make sense. These would only make the settlement of payments and financial transactions impossible in the Eurozone. If the central banks were to settle the TARGET balances with real asset transfers, that would only lead to the imposing of intransigent limits to settlement processes also. Even more important in this proposal is to note that if the TARGET balances were settled by central banks the underlying deviations in the Eurozone banks’ shorter-term funding would remain the same. The underlying causes would best be corrected through restoration of credibility in one way or another followed by subsequent automatic corrections in the banks’ funding flows and in the TARGET balances.
Forced recapitalisations may increase credibility but should not be done as one-off measures. Capitalisation measures need to be complemented with rigorous longer-term viability tests, and should allow restructuring and reorganisation of the banking sector. If these are not allowed to happen, the freezing of present structures will continue.
Conclusions
The growth of the Eurozone banking sector over the last decades has been dependent on the public sector’s implicit protection, which has now become questionable. Permanent funding flow and subsequent TARGET account biases signal a need for change and restructuring in the Eurozone banking sector. However, not much has happened in this respect over the last few years. Moreover, the prevailing attitude of looking at banks as national entities has not made cross-border restructurings any easier. Too much emphasis may also have been placed on recapitalisation as a one-off tool without thinking about complementing measures. In the longer run the restructuring needs will need to be met in the regulated banking markets.
References
Abad, Jose, Axel Loeffer; Holger Zemanek (2011), “TARGET2 Unlimited: Monetary Policy Implications of Asymmetric Liquidity Management within the Euro Area”, CEPS Policy Brief.
Bijlsma, Michiel and Jasper Lukkezen (2012), “Target2 of the ECB vs. Interdistrict Settlement account of the Federal Reserve”, EuroIntelligence.
Bijlsma, Michiel and Jasper Lukkezen (2012), “Why is there no Target2 debate in the US?”, Bruegel.
Bornhorst, Fabian and Ashoka Mody (2012), “TARGET imbalances: Financing the capital-account reversal in Europe”, VoxEU.org, 7 March.
Buiter, Willem, Ebrahim Rahbari, and Juergen Michels (2011), “The implications of intra euro area imbalances in credit flows”, VoxEU.org, 6 September.
European Central Bank, (2011), “Balances of National Central Banks in the Euro Area”, Monthly Bulletin.
Jobst, Clemens (2011), “A balance sheet view of TARGET – and why restrictions on TARGET would have hit Germany first”, VoxEU.org, 19 July.
Merler, Silvia; Pisani-Ferry, Jean (2012), “Sudden Stop in the Euro Area; Bruegel Policy Contributions”, Bruegel Policy Contributions.
Pisani-Ferry, Jean (2012), “Don’t confuse symptom and disease”, Bruegel blog.
Sinn, Hans-Werner (2011), “The ECB Secret Bailout Strategy”, Project Syndicate.
Sinn, Hans-Werner and Timo Wollmerschaeuser (2011), “TARGET Loans, Current Account Balances and Capital Flows: The ECB’s Rescue Facility”, NBER Working Papers.
Tornell, Aaron and Frank Westermann (2011), “Has the Bundesbank reached its limit?”, VoxEU.org, 6 December.
Tornell, Aaron and Frank Westerman (2012), “Has the ECB hit a limit?”, VoxEU.org, 28 March.
Whelan, Karl (2011), “No the Bundesbank has not reached its limit”, VoxEU.org, 12 December.
Wolff, Guntram B (2012), “Collateral is key for TARGET debate”, Bruegel blog.
This article may be reproduced with appropriate attribution. See Copyright (below).
and data as of December 31, 2012....
http://www.frbatlanta.org/cenfis/pubscf/nftv_1203.cfm
The TARGET2 Settlement System in the Eurozone
Gerald P. Dwyer
March/April
The payment system in the eurozone, or TARGET2, has generated a substantial amount of press lately, with various claims flying, such as one article stating that the eurozone central bank system is "massively imbalanced." The article in the German publication Spiegel Online(Kaiser 2012) also suggested that TARGET2 "sounds about as exciting as the title of an accounting seminar." The term "massively unbalanced" applied to eurozone central banking does sound rather ominous, though.1
What's the fuss about?
The fuss concerns balances associated with the European Central Bank's payment system, TARGET2.2 It is possible for banks and central banks in the eurozone to build up liabilities to other central banks in unlimited amounts on this system. The balances in the TARGET2 system represent assets and liabilities, and the "unlimited" balances sound scary to some people. They are not really frightening, though, but there are risks.
Chart 1 shows estimates of the TARGET2 balances on December 31, 2011, for the countries in the eurozone. The positive values indicate asset positions—lending—in these accounts at the end of December 2011. The negative values indicate borrowing through these accounts.
Measured in billions of euro, the negative values represent large amounts of borrowing. Greece's gross domestic product (GDP) is estimated to have been 215 billion euro in 2011, and its TARGET2 liability balance was 109 billion euro at the end of November 2011. Germany—a larger country—has GDP of 2.6 trillion euro for 2011 and an estimated TARGET2 asset balance of 495 billion euro.How do these balances arise?
In the eurozone, the euro circulates in various countries and can move from one country to another. This is similar to the flow of dollars in the United States, where a person may get cash in Georgia and spend it in Washington State. Similarly, someone may transfer funds from a bank account in Georgia to an account in Washington State. The monetary union in the United States relies on the free movement of currency and transfer of funds across state borders to keep the value of a dollar bill and a dollar deposit in Georgia the same as its value in Washington State. The system functions this way because the United States has had a monetary union since the late 18th century.
The European Monetary Union (EMU) also relies on the free transfer of funds across countries' borders to keep the value of a euro the same in all the countries in the EMU. The movement of currency across borders is not even perceptible when the currencies are identical, as euro bills are. (Coins have different designs on their backs, indicating the country in which they were minted.)
The free transfer of funds in banks across borders is necessary to maintain the same value of deposits in various countries. If it were difficult—i.e., expensive—to move deposits from a bank in France to a bank in Germany, a 100-euro deposit in France might not be accepted by a German company in exchange for a good priced at 100 euro in Germany. The free movement of deposits is crucial to maintaining the common value of a euro deposited in a bank in any country in the EMU.
What happens when a depositor wishes to transfer funds from a bank in one country, for example, Greece, to a bank in another country in the EMU, such as Germany? Similar to what happens in the United States, the depositor need not do much more than order an electronic transfer. The rest of the transaction is irrelevant to the depositor.
On the bank's end, the transfer from one bank to another is a decrease in deposits at the Greek bank and an increase in deposits at the German bank. These deposits are liabilities of each of the banks. The German bank will not accept the liability, the deposit, without receiving something in exchange: either an asset or a reduction in some other liability. The Greek bank can satisfy the German bank in various ways. One is to transfer reserves, which are an asset, through the European Central Bank (ECB).
Another way to complete the transaction is for the Greek bank to promise to pay the German bank later, effectively obtaining a loan from the German bank. Or in a more complicated arrangement, the Greek bank could borrow reserves from another bank—for instance, a French bank—at the ECB. The French bank could then transfer the reserves to the German bank in exchange for payment on the loan later.
Transfers of deposits across countries also can be financed by creating TARGET2 balances for central banks. In the eurozone, national central banks lend to banks in their respective countries. If a customer transfers deposits from a private bank in Greece to another bank in Germany and the private Greek bank's best option is to borrow the reserves, the Greek bank can borrow the reserves from Greece's central bank. To facilitate that transaction, the private Greek bank provides collateral to Greece's central bank for the loan. The transfer of assets to the private German bank then occurs through Greek's central bank accruing a liability at the European Central Bank with Germany's central bank—the Bundesbank—accruing an asset at the ECB and providing reserves to the private German bank. TARGET2 balances can change in other ways, but this particular change illustrates how the balances in TARGET2 can arise.
What is the significance of these assets and liabilities?
Interest is paid on TARGET2 balances. In the sense of generating income, positive TARGET2 balances are an asset, for example, for the Bundesbank.
Are these assets a risk to which the Bundesbank is exposed? For example, what happens in the event of a default by the Greek bank? The loans by the Central Bank of Greece to private Greek banks are collateralized. These collateralized loans involve assessing the value of the collateral provided and then generally lending a fraction of the value of the collateral. The difference between the value of the collateral and the value of the loan—known as a haircut—provides insurance against decreases in the value of the collateral. If the value of the collateral does not fall more than the haircut, the Central Bank of Greece can sell the collateral and cover the balance at the ECB in the event of a default by the private Greek bank.
What happens if Greece's central bank defaults? The specifics of what would happen if such an event occurred are highly speculative, but it is certain that the losses by the Bundesbank through the ECB would not be directly related to its TARGET2 balance. In the event of default, losses to individual countries in the EMU would be proportional to their capital contribution to the ECB.
Consider an example for Germany and Greece. Germany provided about 27 percent of the capital of the ECB provided by countries belonging to the euro area (Bank of Spain 2012). Greece's TARGET2 balances are on the order of 100 billion euro. If something happened and those balances became worth half, losses would be 50 billion euro and Germany's exposure 27 percent of that, or on the order of 13 billion euro, a far cry from what might be suggested by its TARGET2 balance of approximately 500 billion euro. Furthermore, Germany's TARGET2 balance itself could be zero and the loss would be the same in this example. It is the net exposure of the ECB to countries that determines any risk associated with TARGET2.
The bottom line
Liability balances in TARGET2 do represent liabilities of the central banks of the respective countries. On the other hand, these liabilities are associated with collateralized loans to individual banks. There is risk associated with the borrower and the value of the collateral.
Asset balances in TARGET2 are assets in the sense that the central banks with positive balances receive interest on the balances. The balances on a national central bank's balance sheet do not represent that central bank's risk of loss, which is shared by other countries in the EMU. TARGET2 balances may well suggest a "massively unbalanced" system, but those balances reflect transfers of deposits that must be freely available in a functioning monetary union.
Gerald Dwyer is the director of the Center for Financial Innovation and Stability at the Atlanta Fed. Thomas Cunningham provided helpful comments. The views expressed here are the author's and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.
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1 A large online discussion has examined the issues touched on here. Initial claims by Sinn (2011) have been subjected to withering criticism and clarification (Bindsell and König 2011, Buiter et al. 2011, European Central Bank 2011, Whelan 2011, Whittaker 2011). The purpose of this brief piece is not to summarize all that discussion or even summarize all the conclusions. Rather, the purpose is to indicate a couple of basic aspects of these balances, aspects consistent in broad outline with discussions by Buiter et al. (2011) and Whelan (2011), for example. Garber (2010) provides an early, clear discussion.
2 TARGET2 stands for Trans-European Automated Real-time Gross settlement Express Transfer system, version two.
References
Bank of Spain. 2012. The share in the capital of the ECB. Bank of Spain website.
Bindsell, Ulrich, and Phillip Johann König. The economics of TARGET2 balances. Unpublished paper, Humboldt University.
Buiter, Willem H., Ebrahim Rahbari, and Juergen Michels. 2011. The implications of intra-euro imbalances in credit flows. Centre for Economic Policy Research, Policy Insight No. 57.
European Central Bank. 2011. Target2 balances of national central banks in the euro area. Monthly Bulletin, October: 35-40.
Garber, Peter. 2010. The mechanics of intra european flight. Deutsche Bank Special Report.
Kaiser, Stefan. 2012. The Hundred-Billion-Euro Bomb. Spiegel Online, March 6, 2012. At Spiegel Online: 'Euro Crisis.'
Sinn, Hans-Werner. 2011. The ECB's stealth bailout. VoxEU.
Whelan, Karl. 2011. Professor Sinn misses the target. VoxEU.
Whittaker, John. 2011. Intra-eurosystem debts. Unpublished paper, Lancaster University Management School.
and.....
http://kkalev4economy.wordpress.com/2012/04/13/bank-of-spain-march-2012-balance-sheet-bundesbank-target2-claims/
Following the release of Bank of Italy balance sheet for March, Bank of Spainreleased the same data today. In this case, the main points to be made are:
The difference with Italian banks which used the LTROs only to finance their negative position with Target2 is significant. Spanish banks keep a large buffer of almost EU90bn in their bank reserve accounts which can cover carry trades and increased Target2 needs for the next months. The troubling fact is that probably most of their tradable assets are now posted long term on Bank of Spain balance sheet (which is a senior creditor) making it hard to find finance in the secured and unsecured money markets. The fact that Spanish banks hold such large amounts on excess liquidity makes the recent increase in Spanish sovereign debt yields rather strange, since that should provide an opportunity for an easy carry trade.
On a related note, Bundesbank also released its Target2 claims for March, which increased by EU68.6bn to EU615.6bn. This is clearly an unsustainable path, especially since on November (before the 3-year LTROs), Target2 claims were EU495.2bn, an increase of more than EU120bn. Almost 25% of the LTROs was used to finance transfers to the German bank system in just 4 months time. The latter should now probably be in a position to basically not need financing from the Bundesbank which might be obliged to provide liquidity absorbing facilities (term deposits, debt certificates) soon. Otherwise, short-term money market rates in Germany will fall to the deposit facility rate, marking significant monetary easing for the Euro core.
Such capital movements (and differences in lending costs and collateral value) make it quite clear that the Eurosystem will face a very stressed situation in the coming months. ECB action will be needed, either in the form of another LTRO or sovereign bond buying (which since the Greek PSI rather complicates than helps the situation).
If one were to extrapolate based on Germany’s Target2 claims data for 2011 and 2012, the best fit would be a polynomial curve pointing to a surplus of over €1tr at the end of 2012. Obviously such trends are clearly unsustainable:
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