The Money View

John Whittaker: Eurosystem balances explained

[The following guest post is by John Whittaker, from whom we have learned much of what we know about how the European payments system works.  See his terrific papers here and here, both of which reward close study.  He has been looking over the last couple Money View posts, and the comments to those posts, and has this to say.]

I'm having some trouble dealing with who said what and where, but let me just try to deal with a couple of points.
1. The SMP (outright) purchases of peripheral government debt ‘by the ECB’ reside on the balance sheets of the NCBs. This may be verified by looking, for instance, at the notes to asset line 7.1 in the accounts in the Bundesbank 2010 annual report. The aggregated figure for SMP across all NCBs is included in the consolidated financial statements of the eurosystem “Other claims on euro area credit institutions in euro”.

2. The confusion about whether the TARGET2 debts of the peripherals are to the ECB or the NCBs is largely irrelevant. According to the ESCB statute, the debts are to the ECB (and so are the claims of those in TARGET2 credit). But what matters is who bears losses in default; legally, this would be all NCBs in proportion to their capital keys but, practically, it would be those NCBs that can afford to. And for NCBs, you can read governments, since they are the owners of NCBs. So I don’t share the concern expressed by some writers about the ECBs or the NCBs running out of capital: all losses ultimately accrue to governments: any NCB that is deemed insolvent (according to the accounting system being used) will be recapitalised by its government.

3. Tornell and Westerman (and others) argue that the Bundesbank’s TARGET2 lending is limited by the zero bound on its lending to its banks (refinancing). This is not correct. If Bundesbank refinancing falls to zero but its banks continue to receive transfers from other eurozone banks, then the German banks acquire claims on the Bundesbank or 'excess reserves'. They would be in the same position as British or US banks are as a result of quantitative easing. Granted, they might not like the low (currently 0.25%) interest rate at the 'deposit facility', but there are other avenues by which the Bundesbank could provide them with a higher reward. The bottom line is that there is no limit to TARGET2 balances (unless the ECB decides to cut eurosystem credit to, say, Greece, which would result in Greece being chucked out of the euro - a point I deal with in my later paper).