To worry or not to worry about the Target 2

Should we worry about the Target 2, or not?. Felix Salmon of Reuters shares his views and explains the subject easily.

If a Spanish woman writes a check to her therapist, the money comes out of her account and goes into the therapist’s account. So long as both accounts are at Spanish banks, this is just a transfer from one bank to another, and the Target2 balance at the Banco de España is unchanged. But let’s say our Spanish depositor decides to move €1,000 from Banco Santander to an account at Deutsche Bank. In that case, the balance on her Santander account will go down by €1,000, and the Banco de España will likewise deduct €1,000 from Santander’s account at the central bank. In Germany, €1,000 appears in the Deutsche Bank account, and in the first instance Deutsche Bank will keep that money in its account at the Bundesbank, so the Bundesbank adds €1,000 to Deutsche Bank’s balance.

Essentially, the Banco de España just destroyed €1,000, and the Bundesbank just created €1,000. That’s fine — they’re central banks, and creating and destroying money is what central banks do. But for simple bookkeeping purposes, everything in the eurosystem has to balance. Remember that what we normally think of as assets, banks think of as liabilities. So Deutsche Bank owes €1,000 to our Spaniard — that’s what it means for her to have €1,000 on deposit at Deutsche Bank. In turn, Deutsche Bank has €1,000 on deposit at the Bundesbank, which is to say that the Bundesbank owes €1,000 to Deutsche Bank. And then the chain goes on: the ECB owes €1,000 to the Bundesbank, the Banco de España owes €1,000 to the ECB, and Santander owes €1,000 to the Banco de España, since Santander effectively needed to borrow money from the Banco de España in order to give that money to Deutsche Bank.

This being high finance, obligations to the national central banks here are collateralized, so the Banco de España is holding collateral from Santander which more than covers the €1,000 it’s owed. On the other hand, the Banco de España in turn is not asked to post collateral at the ECB. Central banks don’t do that sort of thing: there’s no need to post collateral when you can just print money whenever you need it.

Full article here.

Chart courtesy Carmel