Target2

What Is TARGET2?

TARGET2 was the Trans-European Automated Real-time Gross Settlement Express Transfer System, serving as the Eurosystem's real-time gross settlement (RTGS) system for the clearing of euro payments from its phased introduction in 2007-2008 until its replacement by T2 in March 2023. As a critical component of Europe's payment systems [internal link], TARGET2 facilitated the smooth flow of central bank money [internal link] across participating countries, underpinning monetary policy [internal link] operations and a wide array of interbank and commercial transactions. Its primary function was to ensure the immediate and final settlement of individual payments, without netting, thereby minimizing settlement risk [internal link] within the financial system.

History and Origin

TARGET2 emerged from the original TARGET system, which was launched in 1999 alongside the introduction of the euro. The original system comprised interconnected national RTGS systems, leading to some operational complexities. To enhance efficiency, reduce costs, and provide a harmonized service across the Eurozone, the Eurosystem developed TARGET2 as a single shared platform. It became fully operational in May 2008, consolidating the national RTGS systems into a single technical infrastructure. The system was designed and operated by the Eurosystem, which consists of the European Central Bank (ECB) and the national central banks of the Eurozone member states. Its introduction significantly streamlined cross-border euro payments, fostering greater financial integration [internal link] within the European Union.

On March 20, 2023, TARGET2 was replaced by a new system, T2, which retained the RTGS functionality but adopted the ISO 20022 messaging standard and featured a new technical architecture designed for greater resilience and efficiency.

Key Takeaways

• TARGET2 was the Eurosystem's real-time gross settlement (RTGS) system for the euro, processing payments individually and in real-time.
• It ensured the finality of payments by settling transactions in central bank money, thus mitigating counterparty risk.
• TARGET2 was crucial for the execution of the Eurosystem [internal link]'s monetary policy operations and facilitated both interbank and commercial payments across the Eurozone.
• The system handled substantial daily volumes, processing trillions of euros, and was a cornerstone of European financial stability [internal link].
• TARGET2 was succeeded by T2 in March 2023, marking an evolution in the Eurozone's payment infrastructure.

Interpreting TARGET2 Balances

While TARGET2 itself was a payment system, the resulting TARGET2 balances (or Target balances) often became a subject of economic and political debate, particularly during periods of stress in the Eurozone. These balances reflect the claims and liabilities between national central banks within the Eurosystem that arise from cross-border payment flows. A national central bank with a TARGET2 credit balance had a net claim on the Eurosystem, meaning more funds flowed into its jurisdiction through TARGET2 than flowed out. Conversely, a national central bank with a TARGET2 debit balance had a net liability to the Eurosystem, indicating a net outflow of funds.

Significant and persistent TARGET2 imbalances, particularly large debit balances in some countries and large credit balances in others, were interpreted by some economists as indicators of capital flight [internal link] or underlying structural imbalances in the balance of payments [internal link] within the Eurozone, rather than simply payment system mechanics. For instance, high debit balances in certain periphery countries during the European sovereign debt crisis were viewed by some as the financing of capital outflows from those countries by the Eurosystem⁶.

Hypothetical Example

Consider a German company, "EuroGmbH," purchasing specialized machinery for €1,000,000 from an Italian supplier, "IndustriaSpa." Both companies bank with their respective national banks, which are participants in TARGET2.

1. EuroGmbH's bank in Germany initiates a payment request via the German National Central Bank (Deutsche Bundesbank) to IndustriaSpa's bank in Italy.
2. The Deutsche Bundesbank sends the payment instruction through TARGET2.
3. TARGET2 processes the payment in real-time [internal link], debits the account of the Deutsche Bundesbank at the ECB, and credits the account of the Bank of Italy at the ECB.
4. The Bank of Italy then credits IndustriaSpa's bank, which in turn credits IndustriaSpa's account.

This entire process occurs within seconds, ensuring the Italian supplier receives their payment immediately and with finality, and EuroGmbH's debt is simultaneously discharged. The net effect on the national central banks' TARGET2 positions is a debit for the Bundesbank and a credit for the Bank of Italy. This illustrates how TARGET2 facilitated seamless cross-border payments [internal link] within the Eurozone.

Practical Applications

TARGET2 played a fundamental role in the day-to-day operations of the Eurozone's financial system and supported the broader economy. Its practical applications included:

• Monetary Policy Operations: The European Central Bank [internal link] used TARGET2 for its open market operations, enabling the efficient distribution of liquidity [internal link] to commercial banks and the implementation of interest rate decisions across the Eurozone.
  ⁵* Interbank Market Settlements: Commercial banks settled large-value payments and transfers among themselves using TARGET2, crucial for the functioning of the interbank market [internal link] and maintaining financial stability.
• Securities Settlement: While specific securities settlement often occurs on platforms like TARGET2-Securities [internal link] (T2S), the cash leg of these transactions typically settled in central bank money via TARGET2.
• Commercial Transactions: Businesses and individuals could make large-value cross-border payments within the Eurozone through their banks, which utilized TARGET2 for final settlement.
• Market Infrastructure Operations: Other financial market infrastructures [internal link], such as clearing houses and central counterparties, used TARGET2 to settle their payment obligations in central bank money.

The Deutsche Bundesbank, as one of the national central banks, detailed TARGET2's significance in ensuring efficient payment transactions and supporting financial stability in the euro area.
⁴

Limitations and Criticisms

While highly efficient for payment processing, TARGET2 became the subject of significant economic debate, particularly concerning the accumulated TARGET2 balances [internal link] among national central banks within the Eurosystem.

One major criticism, notably advanced by economist Hans-Werner Sinn, was that large and persistent debit balances in some national central banks (e.g., Greece, Spain, Italy) implied an "implicit bailout" or "covert financing" of those countries by the more credit-holding national central banks (e.g., Germany, Netherlands). ³Critics argued that these imbalances represented capital flight from stressed countries, financed through central bank money creation, rather than through private capital markets. This raised concerns about the distribution of risk within the Eurosystem and the potential for large losses if a country were to exit the Eurozone.

Conversely, proponents argued that TARGET2 balances were merely an accounting byproduct of a unified payment system [internal link] in a currency union. They contended that these balances were necessary to facilitate the free flow of capital and payments, especially during times of financial stress when private interbank lending might dry up. They emphasized that the system was designed to absorb shocks and maintain the integrity of the single currency, and that the balances did not represent unbacked lending. The system's robustness in handling high volumes, processing on average just under €2.5 trillion per day, was a testament to its operational strength.

#²# TARGET2 vs. T2

The primary distinction between TARGET2 and T2 lies in their evolution within the Eurosystem's financial infrastructure. TARGET2 was the second generation of the Trans-European Automated Real-time Gross Settlement Express Transfer System, operational from 2007/2008 until March 2023. It provided a harmonized single platform for settling large-value euro payments in central bank funds [internal link].

T2 is the direct successor to TARGET2, launched in March 2023. While it maintains the core function of real-time gross settlement for high-value euro payments, T2 represents a significant technological upgrade. It aligns with the global ISO 20022 messaging standard, which allows for richer data exchange and greater interoperability. T2 is also part of a broader consolidation of Eurosystem services, integrating with other platforms like TARGET2-Securities (T2S) and TARGET Instant Payment Settlement (TIPS) into a more cohesive and modernized suite of services. Essentially, T2 is the enhanced version of TARGET2, built on a new technical foundation to meet evolving market needs and regulatory requirements.

FAQs

Q: Why was TARGET2 replaced by T2?
A: TARGET2 was replaced by T2 to modernize the Eurosystem's real-time gross settlement system, adopt the latest international messaging standard (ISO 20022), and enhance the system's efficiency, resilience, and connectivity with other Eurosystem services.

Q: Are TARGET2 balances still relevant if the system has been replaced?
A: The historical TARGET2 balances refer to the claims and liabilities that accumulated under the former system. While the underlying payment flows now occur through T2, the concept of inter-country balances within a monetary union remains relevant for economic analysis and understanding capital flows [internal link] and financial relationships within the Eurozone.

Q: Who participates in TARGET2 (or T2)?
A: Participation was mandatory for national central banks of Eurozone countries and their respective commercial banks that needed to settle euro transactions with the Eurosystem. It was also open to central banks and commercial banks from non-Eurozone EU countries for their euro-denominated payments. Th¹is broad participation ensured wide reach and efficiency across the European financial landscape.