In a recent VoxEU column, Tornell and Westermann (TW) note that banks in the GIIPS (Greece, Italy, Ireland, Portugal, Spain) countries have borrowed heavily from their central banks (see Tornell and Westermann 2011). They state that “To fund these loans, GIIPS central banks borrowed mainly – via the ECB – from other central banks, in particular the Bundesbank. In order to fund these loans, the Bundesbank sold its holdings of German assets”, that “the Bundesbank will soon exhaust the stock of securities that it can sell to fund further loans to the Eurosystem”, and that this may trigger a significant crisis.
The Eurozone may be in crisis, but, the very real crisis facing the Eurozone is not at all related to the “Bundesbank running out of assets” scenario described by TW. The Bundesbank is not lending money to GIIPS central banks. It is not selling off assets to fund such loans. And there is no looming crisis relating to the depletion of Bundesbank assets.
The Bundesbank is not lending money to GIIPS central banks
The same claim has been made repeatedly this year by Hans-Werner Sinn – ie, that the Bundesbank is lending money to the GIIPS central banks – and has been described as inaccurate by, among others, Buiter et al (2011a and 2011b), Bindseil and König (2011), Jobst (2011) and Whelan (2011), as well as in official publications by the Bundesbank and the ECB (see Sinn’s Vox column Sinn 2011).
In a single country banking system, the transfer of money from one bank account to another is achieved via a deduction from one bank’s reserve account at the central bank and the crediting of the reserve account of the receiving bank. In the Eurosystem, banks maintain reserve accounts with their national country central bank, so there is an additional layer to the transaction.
Consider a transfer from a Greek commercial bank to a German commercial bank. The additional layer is that the Bank of Greece incurs a liability to the Eurosystem (via its TARGET2 payments mechanism) and the Bundesbank receives a credit from the Eurosystem. The Bundesbank’s balance sheet shows an additional asset in the form of a TARGET2 credit and an additional liability in the form of a credit to the German commercial bank’s reserve account.
Note that the Bundesbank is not lending money to the Bank of Greece. It is receiving a new additional asset. It is inaccurate to claim that such a transaction requires the Bundesbank to sell some of its assets to be able to deposit the funds into the Greek residents’ private Frankfurt bank account. No assets need to be sold. Once it receives the TARGET2 credit, the Bundesbank creates the money to deposit in the commercial bank’s reserve account and the Bundesbank’s accounts stay balanced.
There is also no sense in which the TARGET2 credit associated with such a transfer is “secured by collateral” such as Greek government bonds.. This would hold even if the funds transferred to Germany were obtained via a loan from the Bank of Greece collateralised by Greek government bonds. A series of defaults by Greek banks would not change the Bundesbank’s TARGET2 credit by one iota.
This is not to say the Bundesbank faces no risk from a Greek default. The Eurosystem as a whole incurs credit risk due to the acceptance of risky collateral. However, the risk to the Bundesbank in these operations is due to the requirement that it contributes 28% (its ECB capital share) of any funds required to recapitalise the Eurosystem after losses due to loan defaults. This risk is not measured by the Bundesbank’s TARGET2 credit.
The Bundesbank is not selling assets
No evidence has been provided that the Bundesbank is selling assets.
The column by TW included a table showing information from the Bundesbank balance sheet. A line labelled “Private securities owned by central bank” shows a large decline in recent years. What does this line correspond to? TW’s line for “Private securities owned by central bank” equals €224 billion in 2009 and €277 billion in 2008.
The Bundesbank’s own description of its balance sheet for these years tells us that “Lending to euro-area credit institutions related to monetary policy operations denominated in euro” equalled €223.61 billion in 2009 and €277.425 billion in 2008. I’m assuming the resemblance between these figures and those reported is not coincidental, and that the figures described in TW’s table as “Private securities owned by central bank” correspond to the entries the Bundesbank calls “loans”. This raises the question of whether it is accurate to describe these transactions as securities owned by the Bundesbank or as loans. In actual fact these entries correspond to loans, ie, they are securitised loans, specifically repurchase agreements, so the Bundesbank holds a security as collateral prior to the loan falling due. But the value of the loans are less the value of the corresponding securities (ie a haircut is applied to the collateral) so the asset on the Bundesbank’s balance sheet is the value of the loan, not the value of the collateral. Also, the collateral remains as an asset on the balance sheet of the borrowing bank because the bank regains the asset on repayment of the loan and thus the transaction does not correspond to the accounting requirements for ‘derecognition’ of assets.
So, this item – lending by the Bundesbank to German banks – has declined in recent years, from €277.425 billion in 2008 to €37.6 billion in August 2011. The reasons for this are not too surprising. There has been enormous capital flight from the periphery into German banks which, as a consequence, have had far less need than previously to borrow funds from the Bundesbank for liquidity purposes.
Note also that Eurosystem policy in recent years has been to supply banks with a full allotment of funds requested in refinancing operations, so the Bundesbank has not made any conscious decision to reduce the amount of lending it has done.
If “the Bundesbank has done less lending because German banks have asked for a smaller amount of loans” sounds different from “the Bundesbank has had to sell off securities to fund loans to peripheral central banks” that’s because it is. The first statement is true and the second isn’t.
A crisis not about to happen
The Bundesbank is not selling financial assets and it certainly is not about to run out of assets to sell to supply loans to GIIPS central banks, because there are no such loans. Neither will there be a need for the Bundesbank to soon sell its supplies of gold. The Eurosystem would be able to increase its loans to commercial banks in the GIIPS countries even if the Bundesbank is not making any loans to German banks. This is a crisis that is not about to happen.
The most unfortunate aspect of this debate is that the Eurozone is undergoing a real crisis and there is a real need for an informed public debate on potential solutions. Let’s focus on the real problems and forget about fake crises based on a misunderstanding of central bank arcania.
Bindseil, Ulrich and Philipp Johann König (2011), “The economics of TARGET2 balances” SFB 649 Discussion Paper 2011-035, Humboldt University Berlin.
Bundesbank (2011), The dynamics of the Bundesbank’s TARGET2 balance, in Monthly Report, March.
Buiter, Willem, Ebrahim Rahbari, and Jürgen Michels (2011a), “TARGETing the wrong villain: Target2 and intra-Eurosystem imbalances in credit flows”, Citi Global Economics View, 9 June.
Buiter, Willem, Ebrahim Rahbari, and Jürgen Michels (2011b), “TARGETing the wrong villain: A Reply”, Citi Global Economics View, 9 June.
European Central Bank (2011). Target 2: Balances of National Central Banks in the Euro Area, in ECB Monthly Bulletin, October.
Jobst, Clemens (2011), “A balance sheet view on TARGET – and why restrictions on TARGET would have hit Germany first”, VoxEU.org, 19 June.
Sinn, Hans-Werner (2011a), “The ECB’s stealth bailout“, VoxEU.org, 1 June.
Tornell, Aaron and Frank Westermann (2011), “Eurozone Crisis, Act Two: Has the Bundesbank reached its limit?”, VoxEU.org, 6 December.
Whelan, Karl (2011), “Professor Sinn misses the target”, VoxEU.org, 9 June.