European integration and TARGET2 imbalances: correcting the design flaw


From the second half of the 20th century, the economic and political integration of Europe is the largest and longest integration project in human history. It is still a work in progress. Integration on this scale is undoubtedly accompanied by profound difficulties and it would be fair to sympathize with the architects and builders of this project. The difficulties and challenges ahead were envisioned by the Founding fathers of European integration, in particular by Robert Schuman. In his famous speech (the Schuman Declaration) May 9, 1950, he recognized that “Europe will not happen all at once, nor according to a single plan. It will be built by concrete achievements which first of all create de facto solidarity.

Schuman was right! It took another 42 years, during which Europe went through a great deal of political, economic and social transformations. Maastricht was an important step in this integration journey. The the Maastricht Treaty (Treaty on European Union) signed on February 7, 1992 led to the creation of the European Union, but there is no mistaking it: adhering to the creation of a union does not mean integration, especially in terms of economic and monetary. Economic realities are more restrictive and are based on economic fundamentals, which did not change much when signing the Treaty.

The creation of the Economic and Monetary Union (EMU) agreed in Maastricht was not a simple task. Some of these difficulties, including the movement of labor and capital within EMU, have been recognized in the All Saints’ Day manifesto for the European Monetary Union as early as 1975. However, it was assumed in the Manifesto that EMU would not be a cause of high unemployment. A policy mix involving transfers as well as long-term productivity increases could solve the problem.

With hindsight, we see that the situation is less promising. The Maastricht Treaty, which forms the legal basis for EMU as well as the European System of Central Banks (ESCB) and the European Central Bank (ECB), did not provide many operational details on the creation of the EMU, the functioning and operations of the ECB and the national central banks (Eurosystem), or any problem that may arise due to their operation. Further work was entrusted to the European Monetary Institute (EMI), which operated from January 1999 to June 1998 until its successor, the ECB, took over.

The IME and its working groups, including the EU Payment Systems Working Group, worked on the implementation of the Trans-European Automated Real-Time Gross Settlement Express Transfer System (TARGET), which is the Eurosystem’s real-time gross settlement mechanism (RTGS). The system has worked well and, like any other system, is not 100% perfect. Although the word “sregulation”Is part of the TARGET system (or TARGET2 as it is called nowadays), there was no real settlement mechanism per se. On the question of the settlement between the ECB and the national central banks (NCBs), as IME documents published under a public access regime suggest, it was decided that the participating NCBs and the ECB would not impose intraday credit limits on each other, which could hamper the execution of payments.

Since the global financial crisis, the outstanding balances of TARGET2 have swelled to unprecedented levels, leading to the debate on to favor and versus TARGET2 as the ECB’s stealth rescue plan. While the debate is interesting, it just doesn’t make the underlying problem go away. As it stands, and as shown in Figure 1, the imbalances have continued to grow:

Chart 1. TARGET 2 January 2001 – December 2018 balances

Source: Euro Crisis Monitor & ECB

According to Article 104 of the Maastricht Treaty, overdraft facilities or any other type of credit facility with the ECB or national central banks were not provided for in favor of community institutions, central, regional and local public authorities. . Therefore, there was no legal basis for granting credit through the TARGET2 system. However, necessity is the mother of all inventions and under the asset purchase program (APP) the ECB bought government bonds but also corporate bonds for more than 80 billion euros per month, for an amount of 2.5 trillion euros from March 2015 to March 2019. In addition, the Eurosystem also led to huge TARGET2 imbalances. Whether this is a stealth bailout or not is debatable and has been debated enough, but the reality on the ground is that there are huge imbalances. We are where we are! The question is where do we go from here?

A little Argue that if the euro bursts, TARGET2 could lead to huge losses. However, even though we are lucky and don’t have an apocalyptic day in which billions of euros in claims disappear overnight, huge imbalances cause costs to surplus countries in real terms. For example, according to some estimates, it cost Germany up to 17 billion euros in real terms from 1999 to 2014, where the total redistribution from surplus countries to deficit countries is around 40 billion euros. Even those who argued that the imbalances in TARGET2 could be helpful in saving the day and (German) savers, it is clear that they are not a long term solution. Currently, Italy and Spain have deficits of over € 480 billion and € 400 billion, respectively. Given that there is an interest (equal to the rate of the main refinancing operation (MRO) charged by the banks of the Eurosystem) to be paid on the TARGET2 debt, the burden of servicing this debt will become unbearable if the ECB Head towards normalization.

Besides an active participation in the debate around the imbalances of TARGET2, very few actually suggested solutions to deal with them. For example, there is suggestions restrict borrowing or introduce annual repayment with marketable assets, as is done in the US District Fed credit repayment system. Likewise, there has been a suggestion settle TARGET2 balances through a monetary base adjustment in the euro area where euro area members are allowed to withdraw from the Eurosystem based on their paid-up capital, which can then be adjusted against their net claims on the Eurosystem. However, in view of the magnitude of the imbalances, it would be wise to be more strategic and take a number of measures that not only address current imbalances, but also prevent the emergence of future imbalances.

In terms of eliminating the huge persistent imbalances that prevail, it is advisable to address them by a) adjusting the monetary base and allocating liquidity on the basis of the capital key b) redeeming marketable securities ( similar to the Fed) and c) converting some of the TARGET2 debt to equity (similar to contingent convertible bonds (CoCo). Once the TARGET2 claims of surplus countries like Germany, Luxembourg and the Netherlands receive the status of equity, they can buy them back against a larger share of the capital key (which in principle means more voting rights) and the repurchase of assets.

Regarding the modification and development of a institutional framework to prevent the future occurrence of such imbalances, there should be a) limitations on monetary operations and limits to which TARGET2 imbalances can be allowed b) better collateral requirements c) a penalty for lack of discipline and d) a legacy settlement mechanism using “safe” covered bonds issued by NCBs and Member States. These are operational arrangements which will not require any modification of the Treaty. The ECB and the European Commission can decide by qualified majority. Such arrangements would be fair for large debtor countries like Italy and Spain, which, in the current economic outlook, are far from settling these debts.

On the road to integration, Europeans have achieved remarkable achievements which are At first glance evident in the peace and stability of recent decades, during which, according to Churchill’s vowhundreds of millions of workers can rediscover the simple joys and hopes that make life worth living ”. However, it is still a work in progress and the imbalances of TARGET2 are the manifestation that we must do more for a sustainable integration!



  • The post gives the point of view of its author, not the position of LSE Business Review or the London School of Economics.
  • Highlighted picture through Hans, under a Pixabay Licence.
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Mohamed Ali Nasir is Senior Lecturer in the Department of Economics, Analysis and International Business at Leeds Business School, Leeds Beckett University.


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