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Eurosystem Debts Do Matter

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Eurosystem Debts Do Matter MONETARY RESEARCH John Whittaker 1 February 2016 Revised 7 September 2016 Eurosystem debts do matter Since September 2015, the European Central Bank has been publishing Target2 balances – the debts between the national central banks of the eurozone. But this presents an incomplete picture of intra-eurosystem debts because it does not include those arising from the issue of banknotes. The ECB also plays down the importance of Target2 debts as a “normal feature of the decentralised implementation of monetary policy in the euro area”. But if Greece were to leave the euro and its eurosystem debt (currently €98bn) were written off, other eurozone countries would bear the loss, in addition to losses on official loans. The irremovable flaw in the structure of the eurosystem is that there is no effective mechanism for limiting eurosystem debts. And exit risk – the risk that Greece or some other eurozone country with large eurosystem debts will leave the euro – will always be present. © John Whittaker +44 (0) 7752 643946 [email protected] http://www.lancs.ac.uk/staff/whittaj1/EurosystemSept16.pdf Department of Economics Lancaster University Management School Lancaster LA1 4YX www.lums.lancs.ac.uk Intra-eurosystem debts Target2 balances proportion of the total stock of eurozone-wide issue outstanding at any time, according to its share in the An essential feature of European monetary union is 1 capital of the ECB (its ‘capital key’). If the value of that each national central Bank (NCB) in the banknotes issued by an NCB exceeds its allocation, this eurosystem can borrow from the others. This is excess is recorded as a eurosystem liability, and an necessary for clearing cross-border payments through NCB that has issued less than its allocation has a the banking system. If a deposit is moved from a eurosystem claim. As an example, if €100 of Greek bank to a German bank, for instance, the Greek banknotes is drawn in Greece and deposited in bank makes up for its lost deposit by borrowing more Germany, the total issue is unchanged and allocations from its NCB (the Bank of Greece, BoG); the current are therefore unchanged, but Greece’s eurosystem account of the German bank at its NCB (the liability rises by €100 while Germany’s claim rises by Bundesbank) is credited; and the Bundesbank acquires €100. a claim on the BoG. The accumulation of these debts between the NCBs are the Target2 balances which the The increase in a country’s eurosystem liability (or ECB (2015) has now begun to publish. decrease in its claim) is thus equal to net cross-border out-payments via banks and banknote movements, The broad features of the Target2 balances are that which could be current account payments or capital ‘core’ countries such as Germany have claims, whilst outflows unrelated to trade.2 the greatest liabilities are those of the ‘peripheral’ countries Italy, Spain, Portugal and Greece, largely caused by capital flows from the periphery to the core Table 1. Intra-eurosystem claims since 2008. Chart 1 shows the combined Target2 December 2015 € billions liabilities of these four countries, which reached a 1 peak in mid-2012 then fell until mid-2014. banknote total as Target2 adjustment total % of GDP It has been rising again since then, mainly driven by Austria -29.2 28.2 -0.9 -0.3 renewed flows out of Italy and Greece. Belgium -7.8 11.9 4.1 1.0 Finland 20.1 4.0 24.1 11.7 France -29.2 88.0 58.8 2.8 Germany 584.2 -297.8 286.4 9.8 Greece -94.4 -19.6 -114.0 -64.2 Ireland -3.0 -16.3 -19.3 -10.2 Italy -248.9 32.3 -216.6 -13.4 Luxembourg 147.6 -92.7 54.9 112.3 Netherlands 54.7 44.7 99.4 15.0 Portugal -61.7 34.7 -27.0 -15.5 Spain -254.1 83.7 -170.4 -16.4 ECB -83.8 86.7 2.9 others 5.3 12.2 17.5 sum 0.0 0.0 0.0 Negative numbers indicate amounts owed to other NCBs. 1 Euro banknotes An NCB with a negative banknote adjustment has issued a greater value of banknotes than its allocation. Cross-border payments can also be made by drawing source: ECB (Target2); NCBs (banknote adjustment). banknotes from banks in one eurozone country and depositing them in another, and this is another source 1 of intra-eurosystem debts. Banks in each euro country obtain their banknotes from their NCB and, to account for cross-border movements, each NCB is allocated a 2 The increase in a country’s eurosystem liability is identically equal to its overall balance of payments deficit, if the balance of payments is defined to include the current account and all capital flows excluding changes in the 1 An NCB’s ‘banknote allocation key’ is 92% of its capital key eurosystem balance of the NCB. Appendix 1 gives relevant with the remaining 8% allocated to the ECB. accounting identities. 1 Table 1 shows current intra-eurosystem balances, Further, (ECB, 2013)7 including both Target2 balances and banknote “- - the size of the TARGET balances does not pose 3 adjustments. The banknote adjustments, which have additional risk to the Eurosystem or the NCBs given built up more gradually since each country joined the irreversibility of the euro - -“ monetary union, make considerable differences to overall intra-eurosystem debts.4 For instance, However, the euro is not irreversible. Indeed, we Germany’s negative banknote adjustment offsets argue below that exit risk is an unavoidable feature of more than half of its Target2 claim. monetary union. Thus, if a country’s eurosystem debt presents a risk when it leaves the euro, and if there is Risks a non-zero probability that it will leave, then its eurosystem debt is risky. A contingent risk is a risk. Should Germany and the other creditor countries be concerned about their eurosystem exposures? If Eurosystem debts are a peculiar form of debt with no contract or understanding about the terms of Greece left the euro and the BoG did not pay off its 8 eurosystem debt, the resulting loss would be shared repayment . This implies that an NCB cannot default among the NCBs of the other euro countries in on its eurosystem liability because it has no obligation proportion to their capital keys.5 The Bundesbank has to repay. the largest capital key (25.6%) and so it would suffer A country’s intra-eurosystem liabilities are the largest loss. All profits and losses of the nonetheless loans from other countries. For a country Bundesbank accrue to the German government; that has received official loans, its intra-eurosystem hence, if the Bundesbank were to write off part of its liabilities should therefore be added to its official eurosystem claim, this would be a loss for German loans when assessing the risk exposure of the creditor 6 taxpayers. countries. For these reasons, while eurosystem debts are formally debts between NCBs, they are properly Greece’s public debt considered as debts between respective governments. As an example, the progress of the public debt of This applies to eurosystem debts arising from both Greece since 2008 is shown in Chart 2, where we payment channels: cross-border transfers via the define public debt to include the eurosystem liabilities banking system (Target2 debts) and payments via of the BoG, official loans to the Greek government and banknote movements, despite the fact that the ECB outstanding government bonds. Greece’s public debt has chosen to publish only the Target2 component. to foreign governments, shown as the solid line, stood 9 The ECB (2015) plays down the importance of Target2 at €346bn in June 2016 . debts (and, by implication, total intra-eurosystem As a result of capital flight, the Target2 debt of the debts of each country which include the banknote BoG had already reached €80bn by May 2010.Thus, adjustment), describing them as a the Greek state was already enjoying a ‘loan’ of €80bn “normal feature of the decentralised implementation from other eurozone governments via their NCBs, of monetary policy in the euro area.” 7 3 Similar statements appear elsewhere, for instance We disregard NCB claims on the ECB resulting from foreign Bundesbank (2011). assets transferred to the ECB (a total of €40.5 at end 2014, 8 This contrasts with the US where there is annual allocated across the NCBs according to their capital keys). 4 settlement of the inter-district balances of the Feds (Federal Further discussion of the pattern of euro banknote issues Reserve Banks), using Federal government debt or agency and more detail of the accounting practices appear in debt. The US system also differs from the eurosystem in that Whittaker (2011). the Feds are not associated with states: each Fed deals with 5 The eurosystem balances of NCBs are considered as banks in several states and Fed profits go to the US liabilities to or claims against the ECB, but the shareholders government. Intra-eurosystem settlement would be of the ECB are the NCBs themselves. For a description of the infeasible because debtor NCBs do not have sufficient accounting see, for instance, ECB Annual Report, December suitable assets. 2015, page A23. 9 Note that official loans are reported at their nominal 6 Even in an uncooperative departure of a country from the values, which is a poor indicator of their sustainability, given euro, some recovery of its eurosystem liabilities might be the reductions in interest rates and extensions of maturity. expected. Legally, the ECB could seize the collateral security The ESM (annual report 2014, page 30) estimates that these held by the NCB against its refinancing but this would be concessions have reduced the NPV of EU loans to Greece by unlikely to cover more than a fraction of losses.
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