For anyone who fancies a little Target2 controversy on a Tuesday afternoon… we present, straight from the horse’s mouth, the Bundesbank’s own thoughts on the problem of Target2 imbalances via its annual results report:
Unfortunately, the above is only available in German (a language FT Alphaville only has a vague familiarity with). But, in the spirit of sowing even more confusion about Target2, we thought we’d provide a Google Translation to summarise the key points nevertheless.
(German speakers please feel free to correct – though we presume the Bundesbank will be out with an english version eventually. Yes, Bundesbank?)
Banking systems into which flows TARGET2 central bank money, have less need for private financing for refinancing “their” central bank. Institutes in Germany which have their refinancing volumes at the Bundesbank have been steadily declining and there are now even high net deposits at the Bundesbank. The central bank money will continue flowing from them placed in the deposit facility or applied in liquidity-absorbing operations of the Eurosystem. There will be an extension of the Bundesbank’s balance sheet. A sale of assets, such as currency reserves, to compensate for the incoming central bank money is not needed. Nevertheless, a dysfunctional interbank market with banks, which depend heavily on the central bank financing, an undesirable situation.
TARGET2 liquidity can not be created. The payment system is merely the transfer of liquidity (central bank money), the participating banks have already. The provision of liquidity is a key task of central banks. About their design in the EMU, the Governing Council decided in its monetary policy mandate. Central bank money is the main banks on refinancing refi, but in addition, among other things about the structure of securities holdings and transactions on their own responsibility of the national central banks provided.
With regard to the risks arising from the operations of the Eurosystem threatens to distract the debate on the TARGET2 balances of the real challenges. Measures to limit the direct TARGET2 balances are not currently provided. In addition, there are no measures that contribute to a segmentation of the money market or lead to a restriction on the free movement of capital, as opposed to the principles of the monetary union and the single European market.
Risks resulting from the operations by which the central bank liquidity is created. Regarding the participation in the Eurosystem’s refinancing operations on the one hand, the solvency of the counterparty, provided the other hand the provision of adequate collateral. This can lead to losses if a counterparty fails both as well as the questions it is collateral to a treatment prove to be inadequate. These losses are usually worn by a decision of the Governing Council of the partner central banks according to their equity interest in the ECB together. In addition, there are also shops that are excluded from risk-sharing explicitly.
Examples include the provision of short-term liquidity assistance (ELA). What is new is that in December 2011, the Governing Council adopted option for national central banks to accept units under certain conditions, bank loans as collateral. Again, the risk-sharing is excluded, and any losses would be borne solely by the respective national central bank.
The increasing adoption of intermediation functions by € system and in particular the decision for a relaxation of collateral requirements in the context of monetary policy operations, the development of policy-motivated securities portfolio, and the granting of ELA in national responsibility has been in the financial crisis, the risk of euro system increases markedly. Ultimately, always a careful balance between crisis-related measures and made of limiting the risk of central banks. It is not to redistribute the role of an independent monetary policy, solvency risks of banking systems or even between countries, the taxpayers of the monetary union. Such risk taking and decisions regarding distribution fall within the responsibility area of fiscal policy.
The financial risks, which are reflected by the expanded refinancing operations and the purchases of mortgage bonds and are especially created by government bonds, not least reflected in an increased loan loss provisions from the federal bench. Moreover, such short-term liquidity policy not delay tables specific measures of the Eurosystem to curb the acute critical developments ended the necessary adjustment processes in the countries or even replace. The extraordinary crisis measures taken by central banks are limited to so narrow and – if possible – again.
This is true regardless of the development of TARGET2 balances. A hypothetical case discussed in public, in which the parts could manifest itself in negative balances TARGET2-balance-sheet exposures, the withdrawal of a country from the monetary union. Such is unlikely and not regulated by the Treaty on the Functioning of the European Union.
However, it should happen that a country leaving the EMU debt with TARGET2, the ECB claims made against the national central bank initially continued at unchanged levels. Can the central bank withdrawing its debts despite possibly with losses within the Eurosystem and pay off existing securities are not, should be a provision for the remaining difference found. Only if one held a residual demand for uncollectible, would result in a depreciation of the ECB by the balance-sheet loss. On a balance of potential losses of the ECB, national central banks as shareholders decide on the Governing Council with a majority of capital. A loss would reduce profit participation at the national central banks act (as in the German case and reduce the demands of the TARGET2 Bundesbank to the ECB). The Bundesbank, however, is the continued existence of the monetary union in its current form.
In a monetary union with a stable group of participants are the TARGET2 balances not an independent risk. Risks arise primarily from the operations by which the Federal Reserve Bank liquidity is created. The asymmetric development of the TARGET2 balances reflected in particular the unequal impacts on individual national banking communities of the financial crisis. Some banks can not meet their funding needs in the interbank market and therefore increased access to funding through the back € system. Other banks, including on balance, the German banks are considered as “safe havens”. Could flow to them in large amounts of liquidity, so they cut back on their lending in the euro system strong. There are also international investors disinvestment from some peripheral countries.
The claims within the Eurosystem, including the TARGET2-turn net balance owed to the ECB amounting to € 463.1 billion in late 2011, the largest item in the balance of making the German Bundesbank. The positive balance of the TARGET2 Bundesbank establishing a debt of the Bundesbank, the ECB. Since all banks are legally independent and continue to own a balance sheet, the positive balance in TARGET2 Bundesbank’s balance sheet is shown as a receivable. For the Eurosystem central banks with a negative balance due TARGET2 this a liability of the Central Bank to the ECB.
The high balance of the TARGET2 Bundesbank is a consequence of the decentralized provision of central bank liquidity and the existing imbalances in liquidity needs of the banking systems in individual countries. The provision of liquidity is mainly on the monetary policy of the Eurosystem’s refinancing operations, but in addition also on the structure of securities holdings and transactions on their own responsibility of the national central banks.
About the design of monetary policy purposes, the Governing Council decides operations as part of its monetary policy mandate. The TARGET2 system requirements in the euro could affect the risk position of the Bundesbank using two transmission channels. First, the target debt on the balance of the Bundesbank is to be mentioned. For the risk assessment is necessary, however, that these claims are not compared with other national central banks, but always consist of the ECB.
It may also be indirectly affected by the Bundesbank because of their position as owners of the ECB risks to which the ECB is exposed. In the context of TARGET2-balances itself could such investment risks in the hypothetical case, realize that a country withdraws a negative TARGET2 balance of the monetary union and the central bank is not able to meet their liabilities to the ECB. The Bundesbank is the continued existence of the monetary union in its current form. Accordingly, claims are the TARGET2 system € no additional risk is in addition to those risks that result from operations for liquidity provision.
Which as far as we can tell goes something like: “yadda, yadda, yadda… all very conerning, concerning, concerning…a dysfunctional interbank market and transmission channels to consider, but… by and large… Target2 only a problem if and when the Eurozone breaks apart — something the Bundesbank doesn’t foresee happening right now.”
To peruse the original, see here.
Soaring Target2 Imbalances Stoke German Risk Angst – Bloomberg
Getting one’s head around TARGET2 – FT Alphaville
TARGET2 — ECB (includes video)