Risk indicator? Claims Spike in Europe's Central Banking System

The Bundesbank's claims against the European Central Bank have risen to a record level. They will continue to rise, but this doesn't necessarily reflect deeper problems, writes a board member at the German central bank.
Not the leaning tower of Pisa: increasing claims against the ECB aren't necessarily a cause for concern, writes a Bundesbank board member.

The German Bundesbank's Target 2 balances reached a new all-time high of €796 billion ($853 billion) at the end of January 2017.

Target 2 is the central payment system in the euro system and Target 2 balances reflect cross-border payment transactions.

If, for example, more money flows in one day from Spanish banks through this system to banks that are connected to Target 2 (T2) via the Bundesbank, this results in the Bundesbank having a claim against the European Central Bank, known here as the ECB. Conversely, this also results in the Spanish central bank having a liability toward the ECB.

The T2 balances are influenced by all transactions banks conduct on their accounts or for third parties and recently, the securities purchases by the euro system have also affected these balances.

There was a strong increase in T2 balances during the financial and sovereign debt crisis, especially in 2012, which triggered a discussion of the possible risks. Risks can materialize from the T2 balances if a country withdraws from the monetary union. The strong increase in balances was due to imbalances in payment transactions between countries, which is why it was often interpreted as a crisis indicator. After ECB President Mario Draghi's "whatever it takes" remark in July 2012, the situation settled down somewhat and T2 balances declined.

Currently the rise in T2 balances also reflects cross-border securities purchases and is not necessarily an indicator of growing problems in the financial system.

The balances have been rising again since early 2015, to record levels in some cases. The Bundesbank also reported a new record high for the end of January. At the end of the month, the German Target 2 claims were at €796 billion, or $849.9 billion, which was significantly higher than the last record high of €751 billion reached in August 2012.

The reason for the recent increase also lies in the choice of the instruments of monetary policy. The euro system's securities-buying programs are leading to a renewed increase in the T2 balances. This has been especially evident since the beginning of the program to purchase government bonds and other public bonds (PSPP) in March 2015. As part of the buying programs, bonds worth €1.6 trillion had been purchased by the end of January 2017. Another €700 billion will be added by the end of the year.

The difference between buying programs and conventional instruments of monetary policy lies in the settlement. In the case of open-market transactions between a national central bank and a commercial bank, the credit for the liquidity provided is deposited into accounts in the country where the national central bank is located.

In contrast, the settlement of securities purchases also takes place across borders. For instance, the central bank in Spain can also buy Spanish securities from market participants outside Spain.

How the buying programs affect T2 balances depends on the country in which the seller maintains its account and the purchasing central bank has Target 2 claims or liabilities. As a whole, the direct effect of the purchases on a country's T2 balance is the difference between the respective central bank's purchases from banks with Target 2 connections abroad and the sales by domestic banks to other central banks in the euro system.

A balancing of the payment transactions is theoretically possible. However, a large share of the credits take place in a small number of countries, leading to an increase in the T2 balances. For example, the Bundesbank's purchases make up less than a quarter, and yet about 60 percent of all purchases by the euro system are made by banks that maintain their target account with the Bundesbank. They are primarily international banks located in London.

Currently the rise in T2 balances also reflects cross-border securities purchases and is not necessarily an indicator of growing problems in the financial system. Technically speaking, the increase could be interpreted as a result of the cross-border effects of the purchasing programs.

However, there is also no return movement through second-round effects. The overwhelming share of the excess liquidity remains concentrated in the largest creditors in the target system, which could be Germany, for example.

Assuming that the structure of the purchases remains unchanged, a further increase in the T2 balances is likely.


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