In memory of Dr. Andreas Höfert

TARGET2, bank runs and a banking union

A couple of years ago they were rather obscure statistics. But ever since a prominent German economist, Professor Hans-Werner Sinn from the University of Munich, brought them to our attention, they have ranked as one of economists’ most eagerly awaited numbers for analyzing the state of the euro crisis: the TARGET2 balances.

TARGET2, the Trans-European Automated Real-time Gross Settlement Express Transfer System, is basically the system that Eurozone central banks and the European Central Bank use to make payments to each other. It can thus serve as a barometer of cash flows and imbalances within and among the various member countries. Before the euro crisis started to unfold in late 2009 and early 2010, the TARGET2 balances were more or less at zero. However, as the euro crisis has deepened and widened, the disequilibrium within the system has become larger and larger – making central banks from Northern Europe into net creditors and those of crisis countries into net debtors. How has this happened?

Since the beginning of the crisis, the countries of the European periphery have experienced creeping bank runs. People in these countries fear that their countries might leave the Eurozone and reintroduce national currencies, which would then massively depreciate. This fear has led them to withdraw their banking deposits and put the funds either under their mattresses – as the reports of a surge in safety deposit boxes sales there would seem to suggest – or deposit them at banks in Northern Europe, where the conversion risk is smaller.

The migration of these deposits away from crisis countries dries up their cash, which their central banks must then replace using the TARGET2 system. And the amounts we are talking about are not at all trivial. In August 2012, four central banks from Northern Europe made loans to the system in an amount of roughly 1.05 trillion euros, almost all of which went to the five countries hardest hit by the euro crisis (Greece, Ireland, Portugal, Spain and Italy).

Numbers can seem rather abstract, so let’s put them in relation to the number of inhabitants of the countries. With over 750 billion euros in credit granted, Germany is the cornerstone of the whole system. Every German has “lent” over 9,200 euros through the TARGET2 system – although most of them probably don’t know it. The Netherlands, the second-largest lender with 130 billion euros, has a similarly impressive figure of 7,700 euros for every Dutch citizen. But Luxembourg provides the most spectacular illustration: with a population of just half a million inhabitants, the country has loaned the system over 124 billion euros – corresponding to a whopping 244,000 euros for each Luxembourger and almost a million euros for a four-person family.

The main borrowers from TARGET2 include Spain, with 434 billion euros (9,200 euros per capita); Italy, with 290 billion euros (4,700 euros per capita); and Greece with 110 billion euros (10,000 euros per capita). With an overall net debt to TARGET2 of 100 billion, Ireland owes more than 21,000 euros per capita.

All this is not really worrisome as long as the euro exists. But if certain countries wind up leaving the Eurozone or, even worse, if the euro were to collapse, then those large numbers would become net losses for the central banks of the countries doing the loaning. For a country like Luxembourg, this would mean that its central bank would need a capital increase of 124 billion euros, which it could finance either by raising these funds among its taxpayers or, more likely, by using the printing press.

These tensions within TARGET2 and among Eurozone central banks also explain the urgency behind calls to start building the foundations of a European banking union, with both a Europe-wide deposit guarantee and a Europe-wide banking supervision. Only institutions like this can stop the hemorrhage affecting banking deposits in the euro crisis countries.