As we write, the claims of the Bundesbank on the other euro-area national central banks (NCB) through the TARGET2 system are approaching €1 trillion. What do these claims represent? Are they subsidized German loans to other euro-area countries―primarily Italy, Portugal and Spain? Do they signal further financial disintegration in Europe? Or, as large as these numbers are, are they simply a consequence of the complex mechanics related to the construction of the Eurosystem and how it implements monetary operations?

The answer is two-fold: for the first few years of the euro-area crisis―when German claims peaked at €750 billion―imbalances reflected subsidized loans to counter rising financial fragmentation. From 2008 to 2012, funds shifted from banking systems in the periphery of Europe perceived to be under stress, to banks in the core seen as being relatively stable, creating a web of liabilities and claims among NCBs. After 2012, the risk of breakup receded, so the interpretation of renewed increases in TARGET2 balances has changed. Indeed, the doubling since early 2015 is a natural (and almost inevitable) consequence of the manner in which the Eurosystem implements its various asset purchase programs (APPs)―their version of quantitative easing and large-scale asset purchases. Moreover, the impact of the APP expansion on TARGET2 balances has concealed a further, if still incomplete, reversal of the financial fragmentation triggered by the euro-area crisis several years ago.

To be sure, the increase of TARGET2 balances in both periods reflects a credit expansion, but in the latter, the NCBs collectively earn a return that is far more market sensitive. Put differently, the increase of TARGET2 liabilities associated with the Eurosystem’s APPs is backed by marketable assets that could, and probably should, be transferred to the national central banks (NCB) that currently have claims on the system….