Let me start by explaining the chart above this article. Target2 provides an overview of the balances of the national central banks at the ECB (European Central Bank) arising from international trade. For example, if a German car is exported to Spain, the Spanish car buyer has to transfer money to Germany. The Spanish customer makes a transfer and his bank account balance decreases. The Spanish bank transfers the money to an account at the ECB, which then forwards it to a bank in Germany. As a result of the transaction, the Spanish bank has less cash in hand. The bank must compensate for this by asking its customers for money back, less credit, or by borrowing from another bank. The latter was normal practice before the credit crisis and the Target2 balances were relatively small. The banks had a lot of trust in each other and lent each other the money, also internationally, if needed.
During the credit crisis, mutual distrust increased and interbank lending declined sharply. The Spanish bank could no longer borrow from other banks and was forced to limit lending. The bank in Germany left the money with the ECB instead of lending it to another – in this case – Spanish bank. [1] The ECB then took over the role of the banks. As a result, the balances of the banks in exporting countries, such as Germany and the Netherlands, rose sharply, while the balances of predominantly importing countries, such as Spain and Italy, were placed in the red at the ECB. The banks in the red must provide security to the ECB that they will pay off their debts. The ECB runs a credit risk in this regard if the collateral is insufficiently generated if the bank actually defaults. [2] The loss of the ECB will be divided, in proportion to their capital contribution, among the various national central banks. [2] (Read More)
We can clearly see the differences between the strong economies like Germany and Luxemburg and the weak economies like Spain and Italy. These difference are becoming bigger each year and will one day cause a break up of the Euro Zone, it’s just a matter of time. Watch the clip below for more detailed info.
