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TARGET2 – An answer


In answering to a comment by GeroldKeefer to my earlier post on Target2 I would like to make a new attempt to sort things out. Since this topic is still gaining increasing attention among the twitter community and others I put it here in a prominent place.

This is the comment I refer to:

Excuse me, I am not convinced: My idea of a functioning clearing system is that of a temporary buffer that assures timely payment based on existing obligations in cases were the actual payment is somewhat delayed. Obviously, the buffer is used, but it is used excessively starting 2007 and it is not used temporarily but rather permanently since that. Consequently, the imbalance has risen to huge amounts – and those amounts are on the balance sheets of the Central Banks.
The only reason for the large delay in actual payments that makes sense to me is that the respective countries are not able to pay and use Target2 as a loan rather than a clearing system. This makes perfect sense in the case of Greece that is bust since at least 2010. Shoud Greece declare default its negative Target2 account will be a actual loss for the remaining Central Banks in the ECB system. Should the whole ECB system break the Target2 amount will be an actual loss or gain for the respecitve Central Bank, if the debitors are not willing or not able to pay. Where is my fault?

Here comes my answer:

In 2010, Target2 processed 88.6 million payments, with a total value of €593,194 billion. This translates into a daily average of 343,380 payments, with an average daily value of €2,299 billion (ECB). 99.74% of payments were processed in less than 5 minutes, 50% were settled within 29 seconds. Only about 30% of these payments were between participants of different nationality (TARGET Annual Report 2010).

In each of these transactions the system became a buyer to the seller and a seller to the buyer. This is what I mean when I call Target2 a “device” comparable to a box. Tom puts money he wants to pay to Bill into the box and Bill takes money out. In our case the box, Target2, has many doors – the national central banks.

The box, Target2, is an intermediary without own stakes in the payment process. It is pure clearing of ingoing payment instructions:

Clearing – in German: Verrechnung. The Bundesbank calls the balances Verrechnungssalden. These are balances of payment instructions cleared on behalf of the Target2 system via the German side with the Bundesbank acting as one door, or limb, of the device. The balances are  NOT “German” balances outstanding.

The settlement process via Target2 is adding no additional legal or whatsoever quality (such as loan creation or extension) to the positions involved. Target2 is no “permanent buffer”. It is simply instrumental in bringing two parties together in order to ensure safety and efficiency of the payment process.

343,380 individual daily payments – as a rule, these are not “delayed” (otherwise the system would not work for long), but paid out INSTANTANEOUSLY as soon as instructions are sent. The imbalances mentioned in the comment do exist, but they did not arise in the payment process but are rooted in underlying trade and capital movements. In Target2, the sum of ALL balances – those of national central banks of the euro area, non-euro area national central banks and the ECB – is zero.

Saying that “Greece” does not pay makes no sense at all. It implies that of those thousands of daily individual payments all or most Greek participants – in contrast to Dutch, Germans, French … – suddenly decide not to meet their payment obligations from private transactions AFTER instructions have been sent and the money is paid out by the other side. This would be either an accident/default or a criminal act, and it is highly improbable that Greek firms and banks participating in Target2 differ from others in their payment performance and reliability. In that case, nobody would go on trading with them.

In case of country default, the question whether private payment obligations are involved is NO MATTER OF THE PAYMENT SYSTEM. Should a country abandon the euro, the modalities for the translation of private and public contracts into a new currency, and respective future payments, must be decided. But existing private contracts do not become invalid. Maybe a multicurrency solution for Target2 will be found. Maybe the system will be no longer available for processing FUTURE payments from and to the respective country in the new currency. In this case, there probably will be delays as parties have to find other ways and modalities to pay (and actually this may become very worrisome and dangerous, in particular in cases where liquidity bottlenecks turn into solvency problems). But, all this does not concern payments between participants of the country and other Target2 members PENDING AT THAT MOMENT (which, as should have become clear by now, are a fraction of the amounts mentioned in public debates). Real-time gross settlement systems have been created to avoid just the Herstatt-like situation where due to an external event all processes come to a halt, and I do not see why anybody should lose money whose transaction is just caught in actual payment processing at the time that default is declared.

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One Comment
  1. apier permalink

    Hi Reszat, thanks a lot for your explanation and your efforts towards explaining such a not so well-understood (at least for myself) mechanism.
    It is very clear from your explanation that Target2 itself is merely a system that makes efficient payments possible throughout the Euro-area. A payment from an entity that is based in Greece (and has an account with the Greek central bank) to an entity in Germany that has an account with the Bundesbank can be settled quickly using the payment mechanism. (resulting in the 4 legs you have mentioned)

    If the Greek central bank in the above example has euro’s at its disposal it will transfer the amount (on behalf of the Greek bank that ordered the payment) to the German central bank. This (in my understanding) is done through an adjustment in the respective accounts of the two central banks at the ECB. The balance of the German central bank goes up and the balance of the Greek central bank goes down.
    Till here it’s quite straight forward and there is no risk after the settlement of the payment for the ECB and the German central bank.

    But (and here comes my question), what happens if the Greek central bank doesn’t have the euro’s available in its ECB account to make the payment to its German counterpart? (In my understanding) It would go in deficit on its balance with the ECB in order to satisfy the payment to the German central bank (a negative Target2 balance). The ECB would not receive euro’s that it will transfer to the German central bank, but instead it will incur a claim on the Greek central bank and has a liability vis-a-vis the German central bank.

    Does the ECB receive collateral for the money that the Greek central bank owes it?
    Or does the Greek central bank hold the collateral (that is collected from the Greek bank that ordered the initial payment) on its own books?

    The above might be an academic question (i agree it’s a subtle difference), but in the case of Greece leaving the eurozone it will make a very big difference which entity holds the collateral.

    I am looking forward to your answer.
    Kind regards,

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