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The fuss about TARGET2


For months on end there have been rumours that the German Bundesbank is in effect financing the huge debts of Greece and other European countries via the European payment and settlement system TARGET2. In an often reckless and irresponsible manner “experts” and commentators are fuelling anxieties and animosities in an already heated and panic-ridden environment. The following contribution tries to sort out some arguments and clear some misunderstandings.


Take a look at the following figure. What you see is settlement balances in the European payment and settlement system TARGET2 at the end of 2010.

The first thing you may notice is differences. A few countries have positive balances. These are Germany, Luxembourg, the Netherlands, Finland and Italy. Many others have negative balances.

Source: Deutsche Bundesbank, Monthly Report, March 2011, pp 34 f.

The next thing we notice is strong differences in size. With more than €300bn Germany has by far the highest positive settlement balance while Ireland, Greece, Portugal and Spain have noteworthy negative balances, although no individual balance is below – €150bn. Apparently there is no 1:1 correspondence between positive and negative balances of countries in that the excess of claims of one country equals an excess of liabilities of another one.

These figures are accumulated net balances. They show large variations in accumulated differences between cross-border claims and cross-border liabilities of countries. Obviously, end of 2010 in Germany and Ireland the gap between claims and liabilities was much bigger than, say, in Italy where the match was almost perfect. What do these numbers tell us?

Let me emphasize what they do NOT tell: They give no information about gross cross-border payments and their determinants. Hypothetically, these may have been much higher (or lower) in Italy than in Ireland – we do not know. Further, the numbers allow no conclusion about net or gross cross-border payments in subperiods which for example may have been higher, say, in Greece than in France, at least temporarily.

The last point we have to find out is what kind of activities are behind these payments. The Bundesbank mentions three major components with payments carried out via the banking system: foreign trade transactions, securities transactions and lending transactions. All three are reflected in interbank claims or liabilities vis-à-vis the rest of the world and can be settled using TARGET2.

Keeping in mind these points, in principle, we now have all information we need to approach the question who is paying for whom or what in Europe , and how TARGET2 becomes involved, and the time has come to have a closer look at the functioning of a payment and settlement system.

Real-time-gross-settlement in Europe

The Trans-European Automated Real-time Gross settlement Express Transfer (TARGET) system is used to settle cross-border payments individually as soon as orders are sent. The system allows for what is called intra-day finality which is the certainty that transactions will not be unwound if a party fails to settle. Real-time-gross-settlement or RTGS-systems have the disadvantage that, in contrast to former systems, they require a lot of liquidity since during the day orders are not accumulated and netted befor payments are made. RTGS-systems were established in reaction to several incidents which threatened to severely destabilize the international financial system. One of them was Barings. As I wrote elsewhere (Reszat  2005, Chapter 4):

“When in February 1995 one of the oldest British merchant banks, Barings Bank, went bankrupt after one of its traders had lost about ¥850 million on the Singapore and Osaka futures exchanges one widely unnoticed effect was a resulting problem in the then existing ECU clearing system. This threatened to block settlement of ECU50 billion of payments. Barings itself was involved in less than one percent of those payments. The case is a classic example of the systemic risk inherent in large-value net settlement systems. These systems are constantly keeping track of banks’ net positions including thousands of payment instructions in the course of the day. At day’s end the net amounts owed are settled. If clearing becomes impossible for one party, settlement between all participants  is blocked and no payments are taking place at all.”

In contrast to a net settlement system in TARGET2 both legs of a transaction are settled independently of each other via the national central banks. Take the example of the unwinding and repayment of a Greek position by a German investor: Assume a Greek bond falls due for repayment and the German lender wants the money back instead of reinvesting it in Greek bonds again. In this case money is flowing from Greece to Germany including the following steps:

–          A Greek bank is transferring the amount of money to the German investor’s German bank via the Greek central bank. This means that the amount will be credited to the account of the German bank at the German Bundesbank.

–          Technically, now the Bundesbank has a new liability (equal to the amount from the Greek investment on the central bank account of the German bank).

–          But at the same time, the transaction generates a claim for the same sum of the Bundesbank on the sending Greek central bank.

–          The Greek central bank in turn debits the central bank account of the originating Greek bank.

In my interpretation the third step is what observers think they see in the figures for the German TARGET2 settlement balances: Claims of the Bundesbank on Greece. What they overlook is

a) that the position in our example is not a claim on Greece, or on the Greek central bank, but on the  Eurosystem, on TARGET2. The source of the misunderstanding is probably the fact that TARGET2 does not provide a central counterparty which would serve as a seller to all buyers and a buyer to all sellers. Instead, the participating central banks are directly offsetting the positions as soon as orders are reaching them.

b) that such a claim is only one of two legs of a transaction that is merely settled via central bank cooperation. The other leg is the liability the Bundesbank has to the German bank which is receiving the payment.

Payments via TARGET2 in general involve four parties: two central banks and the initial payer and receiver. The payment may result from an export or import of goods or services, from a securities sale or purchase or from cross-border lending and borrowing. In these and other cases the principle is always the same: four legs with a match of claims and liabilities. As the Bundesbank writes:

“From a euro-area perspective, TARGET2 balances largely disappear, just like the national current-account balances within the euro area. The claims of the Bundesbank (and other national central banks) on the ECB are offset by the liabilities of other national central banks”.

Volumes and Values of Transactions in EU Payment and Settlement systems

Source: ECB: Statistics Pocket Book, September 2011.

The Role of the ECB

The ECB comes into the picture by the fact that it is the keeper of the TARGET2 balances within the Eurosystem: Usually, the claims and liabilities generated at the national central banks by thousands of transactions (as the above table shows the monthly volume of transactions between 2005 and 2009 ranged from about 300.000 to 400.000 payments) do not fully balance out over the course of a day. The outstanding claims and liabilities of all national central banks are then transferred to the ECB at the end of the day and netted out.

Why is the TARGET2 settlement balance for Germany so high? The Bundesbank states that, above all, this is due to the current tensions in the money market and the financial sector. Currently, Germany’s cross-border payments are far from balanced reflecting, for example, changes in banks’ refinancing operations in the euro area. While funds tend to continue to flow into Germany from non-bank payments from current-account surpluses and securities transactions as well as from banks’ own operations, there is a growing unwillingness or inability of German banks to lend funds to foreign financial institutions. The result is that there are more payments channeled through TARGET2 in one direction than in the other.

Which are the risks? There is always a danger that one leg of the transaction is paid and the counterparty is not willing or able to fulfil its part of the business. For this eventuality banks have to provide collateral. Assume, in the example the Bundesbank has paid out the amount to the German bank, but the Greek bank fails and the Greek central bank is not able to collect the money because collateral is insufficient to realize the full amount. In this case an actual loss occurs, but this is not borne by the Greek or the German central bank alone, but by the Eurosystem as a whole. The cost of the loss is shared by national banks in line with the capital share. Accordingly, the Bundesbank has to pay 27% of a loss no matter in which country it occurs.

Confusion partly stems from the dual role of the ECB as central counterparty for TARGET2 balances and as central bank for the euro area. In the latter function it offers member banks the opportunity to both posit cash there and get cash against collateral establishing borrower/lender relations. Both types of activities trigger payments which are settled using TARGET2. Again the question is: Which are the four legs?

Assume an Italian bank is getting a loan from the ECB against collateral. Four parties are involved: the Italian bank, the Italian central bank, the ECB in its role as loan-granting central bank of the euro area (only in this role money is owed to it by the Italian bank) and the ECB as participating member central bank of TARGET2 which is processing the related payments.


So, as Robert Peston asked in a recent article about TARGET2 balances, what’s all the fuss about?

The answer is that those “experts” and observers obsessed with the idea that against official claims the Bundesbank forces German taxpayers to pay for the debt of Italy, Greece and other countries simply confuse money flows generated from debtor/creditor relations with the processing and settlement of related payments. Claims and liabilities in a payment and settlement system must not be regarded isolated for individual members. There is one recipe to pick one’s way through this jungle of positions and activities: Search for the four legs! Then it becomes clear where the money flows, who gives it and who takes it.

From → Policies

  1. Great post. My only question is what happens with a T2 liability of a country in the unlikely scenario that it leaves the euro?

    • Thank you for your comment. This is an important question. Basically, if the currency changes only denomination changes, claims and liabilities remain the same. If banks from that country stop payments collateral is used. If collateral is insufficient, losses are divided between all paritcipating central banks according to their shares. TARGET2 technically makes sure that payments are made, all else is not a payment-system problem.

      • This is not entirely accurate. If Greece for example were to leave the Eurosystem, the Greek central bank could simply walk away from its EUR 100bn in T2 liabilities. Plus it holds the collateral for Greek banks. It would simply convert any loans it has out to Greek banks into drachma and still hold their collateral. The 100bn of T2 liabilities becomes the problem of the remaining Eurozone NCBs. Each would have to take its prorata share of losses. There is no way around it. That is why Bundesbank is getting so concerned (

      • Maybe you would like to have a look at my reply to GeroldKeefer who raised some similar points: . I am not aware that the Bundesbank worries about the point you make, and behind the link to your own article I can find no evidence for this except your own assertion.

  2. Please, correct me, if I’m wrong.

    Currently TARGET2 is collective cross-loss-insurance scheme,
    which can be easy refactored to a set of bilateral liabilities,
    which if properly accounted would significantly change
    official debt ratios of member states?

    Is there any reason why ELA liabilities of Irish CB to Eurosystem,
    covered by Irish government guarantees
    (or even better, not covered by gov. guarantees)
    would not be counted as Irish national debt?

  3. Thank you for your comment which gives me the opportunity to stress my point again: A payment and settlement system is NO insurance scheme. It is correct that if a payment order for you is sent to TARGET2 you can be sure to get the money no matter what happens to your counterparty. But this certainty comes from the way the payment is processed. A payment and settlement system is, to put it simply, a technical device standing between borrower and lender, or payer and payee. Let me give you an example:
    Imagine you owe one euro to your next-door neigbour. You want to give it to him but you have a cold and must stay inside. From the window you see your elder brother in the street. You ask him to go to the neighbour and give him a euro, and you tell him that you will pay him back later. The moment your brother (whose name accidentally is Target) agrees and does as he is asked your neighbour gets the money. If the next minute you change your mind and no longer intend to pay – bad luck for your brother, who loses a euro, but not for the neighbour.
    Now imagine instead that when you call your brother from the window he is sitting on a bank holding hands, and although he would like to help you he would not want to leave his girlfriend if only for a second. He is looking around and sees your younger brother (accidentally called Buba) playing with the neighbour’s son (accidentally called Boe). He calls Boe to run to his father (the neighbour) and give him one euro reassuring him that as soon as he is paid by you he in turn will pay the euro back to him (Boe). Then Target asks your younger brother Buba to run and fetch the euro from you. If Boe agrees, again, the neighbour has the money no matter what happens in your familiy.
    Where are the four legs of the payment process I mentioned in the text? In the first example, your neighbour has a claim on you (1), you ask (i.e. you send an order to) your elder brother Target (2), your elder brother Target pays a euro to the neighbour (3) and comes to you to get his money back (4).
    In the second example, there are two additional intermediaries (Buba and Boe) acting on behalf of you and your neighbour. Again the neighbour has a claim on you (1), you ask/order your elder brother Target to deliver the money (2) Target pays the neighbour via his son Boe (3) and asks young Buba to fetch him the euro from you (4).
    None of all this changes the debtor/creditor relation between you and your neighbour.

  4. You gave your son Boe one euro and asked to bring it to your neighbor. But your son inadvertently lost the coin. He decided not to tell you about the trouble, instead called your neigbours daughter Buba and instructed her to pay her parent one euro, else his special relationship with her (accidentally called target) can be broken.

    Accidently your neighbor had entrusted his daughter a few coins for grocery, so she used one of them to pay your liability, as told by Boe.

    Exactly as you said, if a payment order for you is sent to TARGET2 you can be sure to get the money no matter what happens to your counterparty.

    Your liability seems to be fulfilled but is not properly cleared. Until your neighbor doesn’t check his family finances, there is illusion like money to Buba owes “the target”. Oops… the target so far is only technical device standing between borrower and lender.

    It appears, somebody still owes money, or involuntary funding act occurred and loss is going to be recognized.

    • Thank you for trying to explain your point in more detail using my little example. In my view however in making one central bank “lose” money and letting the second pay instead you are stretching the analogy too far thereby shifting the focus away from payment and settlement of a given transaction to the establishment of a second, new one outside the TARGET2 frame. In your example the two central banks are entering a new contract (one giving a gift to the other). This is independent of the settlement of the first transaction. Imagine TARGET2 as a box. Someone is putting money in, another is taking it out. The system of central banks is the box. It has no influence on the relation between the two parties.

  5. Thanks for the brilliant post. Just a quick question
    You said “If banks from that country stop payments collateral is used”
    What collateral are we talking about here? Is it the one that banks post in MRO/LTRO/FTOs? It shouldnt be, as it belongs to them. So, what is it?

    • Thank your for your comment. I am glad to learn that you liked it. To answer your question: In order to participate in the TARGET2 system banks have to provide collateral. These are securities they own which, in case they do not fulfil their payment obligations, will be used to cover losses. This is perfectly in order. You may compare the principle with pawn broking, where the borrower is providing something valuable which is sold if the loan is not paid back.

  6. Hi,

    great post! I wondered how save Target-2 is with respect to a central bank or governement chosing no to play fair. Let’s assume Greece choses to leave the Euro and the great government seizes all collateral Greek banks posted to gain credit from the Greek central bank. Would that cause a loss to the other participants of the payment and settlement system?


    • Thanks for commenting and I am sorry to be late answering. This is a good question which, as I understood, refers to the nature of ELA assistance in the euro zone. Frankly, I am not sure about this: If Greece would leave the euro and the government would seize collateral Greek banks posted with the Greek central bank (why should this happen?) at first view I would say this would be entirely a national problem, since the credit exposure was taken by the national central bank. On the other hand, as far as I know ELA loans have to be agreed by the ECB in advance and I don’t know how this influences the nature of the loans and respective liabilities.
      However, it needs to be stressed that this question has nothing to do with the payment system. As I wrote, there is a confusion arising from the dual role of the ECB as central counterparty for TARGET2 balances and, at the same time, as central bank for the euro area. Lending to EZ banks (directly or via national central banks) is done in the latter role and has nothing to do with the ECB’s function in TARGET2. If lending against collateral was done by the ECB a loss would also be the ECB’s – and its shareholders’. (That the latter are national central banks from both within and outside the euro area which also participate in Target2, admittedly may further add to the confusion.)

  7. Thanks, Beate, for your answer. I appreciate it a lot. Unfortunately, I don’t quite get the point. I figure, this is due to the fact that I maybe misunderstood somethings on how the ECB refinancing transactions are conducted. I’m sorry that I’m becoming a bit lengthy here…

    My understanding of the process is like this:

    A EZ banks wants central bank money so it participates in a ECB tender where it can swap e.g. a government bond against liquidity. During the transaction any change in market value of the bond will cause margin calls that ensure the ECBS is always sufficiently collalteralized in its exposure towards the EZ bank. Upon maturity of the transaction, the EZ bank returns the money and the collateral (the bond) is released. However, the ECB doesn’t settle these transactions itself. The local central bank does it. So both the collateral and the margin deposits are located there.

    Now let’s add Target-2 to the example:

    EZ bank A in Greece swaps the bond against central bank money. For whatever reason, it transfers the money to another EZ bank B in Germany. The Greek central bank will, via ECB using Target-2, move the money to the Bundesbank which, in turn, will give it to bank B. The Bundesbank now holds a claim against the ECB and the ECB a claim against the Greek central bank.

    The ECB can be sure that the Greek central bank can service the claim as it still holds the bond as collateral. However, and this was my point, the ECB cannot be sure that the Greek central bank will service the claim as it simply might chose not to do so. Most likely this will never happen unless the central bank is forced by the government. Why would the government do this? Simply, because in a default it will not be willingly to transfer any funds abroad. As it will be cut off from the financial markets, it will need any Euro it can get hold of.

    • You are very welcome. I thought about your argument which, in my feeling, is driving us a bit far away from the initial point. National central banks in Target2 are acting on behalf of the ECB. There is no room for individual decisions (“for whatever reasons” as you write). Money is shifted from one central bank to another if there are respective transnational payments to be processed. Central banks a do not “decide” about the use of money, they simply channel it from payer to payee.

  8. Amado permalink

    Hi there, many thanks for your post.

    I have a simple and surely naive question, what are the differences between TARGET2 balances and a conventional balance of payments?

    It seems to me that the bulk of the transactions reflected in a balance of payments are the ones explained above for TARGET2 (export & imports of goods and services, securities sales or purchases, lending & borrowing), regardless of the channel through which they may’ve been made or the country to/from which the transaction is made.

    • thank you for your question which, considering the current debate, does not seem too naive. Target2 and BOP: The former is a settlement system where payments are booked immediately, the latter is an accounting system for a country’s economy over longer periods of time as statistical informations are coming in. Target is handling each transaction individually, the BOP is about aggregates. Both serve different purposes: Target serves as a central counterparty, as a buyer to all sellers and a seller to all buyers IN the payment process. The BOP is a statistic, an information device about one aspect of the state of an economy AFTER transactions are completed and statistically captured.

  9. GeroldKeefer permalink

    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?

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