TARGET2 - why EUR is F-D?
The Trans-European Automated Real-time Gross Settlement Express Transfer system, more commonly referred to as TARGET, represents the core of the Eurozone’s payment infrastructure. As the real-time gross settlement (RTGS) mechanism for the euro, it plays a pivotal role in enabling cross-border payments within the Economic and Monetary Union (EMU). Yet, beneath its ostensibly neutral function lies a more profound reflection of systemic asymmetries and monetary fragmentation. While mainstream narratives present TARGET as an efficient facilitator of euro-denominated transactions across the European Union, a more rigorous examination—particularly from a Eurodollar and shadow banking perspective—reveals a series of unresolved tensions in European monetary integration. The TARGET system is not merely a payments mechanism; it is an accounting mirror that reflects the deeper failure of the euro to function as a genuinely unified currency.
TARGET2, the current iteration of the system introduced in 2007, facilitates interbank settlements among national central banks (NCBs) and the European Central Bank (ECB). When a bank in one member state needs to send funds to a bank in another, the corresponding national central banks adjust their positions within the Eurosystem accordingly. For example, if an Italian bank transfers funds to a German bank, the Bank of Italy reduces the account of the sending bank and simultaneously increases its liabilities within the TARGET2 framework. The Bundesbank, in turn, increases its claims by crediting the receiving bank’s account. From the outset, this system was meant to be self-balancing over time, assuming a roughly symmetric flow of payments between member states. However, as has become clear since the global financial crisis of 2008, these assumptions proved untenable.
In the years following 2008, the balance of TARGET2 claims and liabilities grew dramatically unbalanced, with surplus countries like Germany, the Netherlands, and Luxembourg accumulating massive credits, while deficit countries such as Italy, Spain, and Greece registered increasing liabilities. At their peak, Germany’s TARGET2 claims approached €1.2 trillion, while Italy and Spain’s liabilities surpassed €500 billion each. Importantly, these balances do not settle in any meaningful monetary form. No cash is exchanged; no reserves shift physically or electronically across borders in the traditional sense. Rather, these are intra-Eurosystem bookkeeping entries—ledger-based IOUs between central banks, with the ECB acting as an intermediary.
This is where the analytical focus must shift from the infrastructure itself to what the imbalances represent. From a conventional viewpoint, persistent TARGET2 imbalances are dismissed as benign consequences of decentralized monetary operations. Proponents argue that such imbalances merely reflect the operational dynamics of a single currency system where free movement of capital and goods naturally leads to asymmetrical positions over time. However, this explanation underestimates both the scale and persistence of the phenomenon. Drawing on insights from shadow banking mechanics, suggests something far more structural and disconcerting. These imbalances are not just passive byproducts of trade flows or temporary portfolio rebalancing. They are, instead, indicative of the deep monetary fractures within the euro system—an ostensible single currency that lacks a unifying banking and fiscal architecture.
One must recall that the euro was designed without a centralized fiscal authority and without full harmonization of national banking systems. Each national central bank retains certain domestic regulatory prerogatives, and banking sectors operate within their own legal, supervisory, and accounting regimes. This fragmented structure creates frictions, especially under duress. In times of crisis or uncertainty, banks and investors in peripheral countries exhibit a marked preference for the safety of core countries’ institutions, especially those backed implicitly by more credible sovereigns. This “intra-union flight to safety” generates sustained capital flows out of periphery nations and into core regions. Since there is no mechanism within the TARGET2 system to settle these flows in any final sense, they result in the accumulation of TARGET2 liabilities and claims that have, to date, shown no signs of meaningful reversal.
Crucially, the persistence of these imbalances reflects the reality that the euro, unlike a truly unified currency such as the U.S. dollar, is not embedded within a single fiscal and banking system. The analogy to the U.S. Federal Reserve’s district banks breaks down under scrutiny because the Fed’s regional branches are part of a singular sovereign structure, with transfer mechanisms—such as federal taxes and spending—that automatically reallocate resources across regions. The euro area lacks any comparable system of interregional adjustment. Consequently, capital that flees Italian or Spanish banks for perceived safety in Germany creates not just accounting imbalances, but real systemic stress. The only thing that prevents full monetary breakdown is the ECB’s willingness to indefinitely tolerate these imbalances on its books—essentially acting as a clearinghouse for a dysfunctional system.
This situation bears a striking resemblance to the dysfunctions in global shadow banking since the 2008 crisis. Just as the interbank and collateral flows in the offshore dollar system fragmented due to mistrust, credit concerns, and collateral scarcity, so too has the euro system experienced fragmentation in its own cross-border monetary plumbing. The Eurodollar system prior to 2007 functioned on the basis of unimpeded, wholesale credit creation between counterparties. Trust, efficient collateral reuse, and deep interbank networks enabled enormous elasticity. But the crisis exposed the fragility of those mechanisms. Institutions no longer trusted each other. Collateral chains shortened. The system lost its ability to self-expand. Similar mechanisms have been at work within the Eurozone, where the TARGET2 system now functions as a patch over a broken cross-border credit and liquidity network.
What makes this even more revealing is the ECB’s own quiet acknowledgment of the issue. Rather than attempt to settle or reduce TARGET2 imbalances through institutional reform or structural adjustment, the ECB has allowed the system to become an indefinite ledger of imbalances, essentially functioning as a quasi-fiscal mechanism without any democratic legitimacy. This de facto monetization of capital flight is particularly problematic because it allows deficits to be passively financed without proper market discipline or structural correction. Meanwhile, surplus countries continue to accumulate claims that may never be redeemed. This asymmetry fosters resentment, political instability, and questions over the ultimate sustainability of the monetary union.
From a technical perspective, the TARGET2 system also reflects a core aspect of modern monetary systems — namely, the abstraction of money into ledger entries devoid of physical representation. Like the Eurodollar system, TARGET2 balances are not money in the traditional sense. They are not cash, nor even central bank reserves in any practical liquidity sense. They are accounting entries representing claims and liabilities that may have no final settlement. Their persistence reveals not just accounting quirks, but a deeper truth: modern monetary systems function less as cash-based systems and more as interlocking networks of promises and expectations. When trust in those promises weakens, or when their legal or institutional backing is perceived as uneven, the system begins to fracture—first silently through imbalances, then visibly through crisis.
Ultimately, TARGET2’s growing imbalances are symptomatic of a broader failure of euro design. The lack of a unifying fiscal authority, the absence of risk-sharing mechanisms, the incomplete harmonization of banking regulation, and the political constraints on sovereign debt mutualization have all contributed to a system in which imbalances are not a phase to be corrected, but a structural feature to be endured. This turns TARGET2 into something quite different from its initial conception. It is no longer merely a settlement mechanism. It has become an institutional crutch that sustains an illusion of integration while obscuring the persistent divergences within the monetary union.
Resolving the structural dysfunctions embedded within the TARGET2 system necessitates more than mere technical adjustments to payment infrastructure. It requires a comprehensive rethinking of the institutional, regulatory, and fiscal architecture of the euro area. The persistent and asymmetric imbalances observable in TARGET2 are not isolated malfunctions; they are symptomatic of a broader systemic incompleteness. Therefore, any viable resolution must address the root causes of financial fragmentation, institutional mistrust, and the lack of final settlement mechanisms in cross-border monetary flows.
The most direct path toward alleviating TARGET2 imbalances would be the establishment of a true fiscal union within the Eurozone. This would involve the creation of centralized fiscal authority with redistributive capacity, a European Treasury empowered to issue common debt instruments such as Eurobonds, and the harmonization of fiscal policy across member states. Under such a regime, asymmetries in capital flows would be partially neutralized through direct fiscal transfers or automatic stabilizers. In essence, the European Monetary Union would evolve into a political union with fiscal sovereignty, paralleling the federal structure of countries like the United States. This would allow the TARGET system to perform its original function—facilitating liquidity flows—without simultaneously becoming a proxy for unresolved credit risk between nations.
However, the political feasibility of such a transformation remains limited. National sovereignty concerns, particularly in surplus countries, present formidable barriers to fiscal integration. Thus, alternative, less politically contentious solutions must also be explored. One such path involves the enhancement of collateral mobility and harmonization across the Eurozone. In the Eurodollar framework, the collapse of collateral velocity—especially high-grade securities like U.S. Treasuries—played a key role in monetary tightening and disintegration. Similarly, in the Eurozone, national idiosyncrasies in collateral eligibility and reuse inhibit the free flow of funding. By standardizing collateral eligibility criteria, enabling cross-border pooling of securities, and encouraging the development of transparent, pan-European repo markets, the ECB and national central banks can foster greater trust and fluidity in interbank markets.
Technological innovation offers additional pathways for reform. Distributed ledger technology (DLT), for example, holds promise as a structural solution to the problems of opacity, trust, and inefficient settlement. A permissioned, euro-area-wide DLT infrastructure—operated by central banks but accessible to both banks and authorized non-bank financial institutions—could provide real-time visibility into cross-border obligations, collateral availability, and settlement flows. Smart contracts could enforce regulatory and collateral compliance dynamically, reducing counterparty risk and allowing real-time credit assessments across borders. Such a system would effectively mirror the logic of Eurodollar ledger money, but with transparency and programmability layered atop. In doing so, it could restore confidence in cross-border liquidity provision and reduce the accumulation of TARGET2 imbalances by enabling more direct, final settlement pathways.
Moreover, the introduction of a central bank digital currency (CBDC) tailored for wholesale financial use—especially one designed for cross-border settlements—could help mitigate the frictions that currently accumulate within TARGET2. A euro-denominated CBDC used for interbank payments could operate alongside existing RTGS infrastructure, or potentially replace it in the long run. If designed with interoperability in mind, such a CBDC would allow for near-instant finality of settlement across borders, reducing reliance on accounting-based net positions and replacing them with tangible, cryptographically secured flows. Importantly, the design must preserve privacy, allow for layered money architectures, and integrate with existing collateral systems. In such an environment, liquidity could become genuinely fungible across the union, and the asymmetries in national balances would become more self-correcting.
A further, perhaps more nuanced approach involves redefining the legal and accounting treatment of TARGET2 balances themselves. Currently, these balances are treated as intra-central bank positions with no maturity, interest rate, or settlement requirement. Recasting them as contingent liabilities or formal credit exposures with associated terms and conditions could introduce discipline and accountability. Such recharacterization might include haircut provisions, collateralization requirements, or interest rate penalties for persistent overdrafts. While this risks financializing the core of central bank cooperation, it may serve as a necessary discipline in the absence of broader reforms.
Finally, just as the Federal Reserve has used dollar swap lines to backstop global dollar funding markets, the ECB could implement a structured intra-union backstop facility to redistribute liquidity in times of asymmetric shocks. This facility would operate automatically, governed by transparent rules and risk-weighted assessments, thereby reducing political interference and moral hazard. Such a mechanism, ideally integrated with modern collateral and settlement technologies, would reduce the buildup of structural imbalances and improve systemic resilience.
