Is Target2 Sustainable?

What is Target2 and how does it fit into the EU’s NextGenerationEU recovery programme?

Target2, created in November 2007, is the real-time gross settlement (RTGS) system for the euro area, which facilitates the transfer of funds between banks in the EU.

It is the bailout system that keeps the euro afloat, by allowing banks to initiate payment orders that are sent to their national central bank and then to the ECB, which acts as the settlement agent and debits the account of the originating bank and credits the account of the receiving bank.

It is an important part of the EU's 750bn euro Next Generation recovery programme, which marks the first step towards fiscal union, and serves as an experiment in debt mutualisation and the creation of a fiscal transfer system.

What risks are associated with Target2?

Target2 facilitates the movement of cross-border, private-sector capital from financially, fiscally and politically weak countries to member countries perceived as stable and secure during periods of distress and economic turmoil.

Also, due to the fact that Target2 liabilities are a part of the national debt of the debtor country's government and are not collateralised if a debtor member country exits the European Monetary Union and declares insolvency, Target2 creditor countries’ claims would be replaced by real losses. 

How have Target2 balances evolved over time?

Target2 imbalances have risen steadily through crises, beginning with the Global Financial Crisis. Spain, Greece, Ireland and Portugal had rising Target2 liabilities while Germany, Luxembourg and the Netherlands had rising Target2 claims.

During the European sovereign debt crisis, capital flight from crisis-hit countries to perceived safe havens further widened these imbalances. This was then exacerbated by the ECB experimenting with unconventional monetary policy tools. 

The Covid-19 pandemic has also had an impact on Target2 imbalances with countries worst hit by the pandemic and weak fundamentals having rising Target2 liabilities and safe havens having rising Target2 claims. 

As of November 2021, Italy and Spain accounted for 41% and 38% of total Eurosystem Target2 liabilities respectively.