Interpreting TARGET2 balances
BIS Working Papers No 393
The increase in the TARGET2 balance for the Bundesbank has led to a debate in Germany about the appropriate interpretation and policy response, if any. In this paper we review the evidence for the current account financing interpretation, and find it wanting in explaining the data in 2012. BIS international banking data, by contrast, point to the importance of TARGET2 balances as a symptom of a reduction by core European banks of credit previously extended to borrowers in peripheral Europe. These same data suggest that banks headquartered outside the euro area, particularly UK banks, boosted TARGET2 balances by hedging redenomination risk. As such, TARGET2 balances reflect not only concern regarding actual credit exposures but also potential currency exposures.
JEL classification: E42, E44, E52, E58, F32, F34, F36.
Keywords: payment system, financial crisis, monetary policy, international lending