Happy New Year! A number of readers have asked to see a diagram of the TARGET2 process in the eurozone. The diagram below shows how the euro movements are offset, while imbalances in the ECB IOUs create imbalances in eligible collateral. Collateral gets "trapped" at the periphery central banks, while Bundesbank accumulates ECB IOUs.
There have been some questions about the collateral flows between the banking system and the central banks in the diagram above. When deposits leave a "periphery" bank, the periphery central bank has to lend to the banking system and take in collateral to replenish the liquidity balances in the banking system of that nation.
German banks, awash with deposits, reduced their Bundesbank borrowings from €277 billion in 2008 to €38 billion in 2011. As they repay their loans, collateral used to support those loans is returning back from Bundesbank to the banks (on the left side of the diagram above.)
For those interested in learning more about TARGET2, here is a decent explanation from Gardenofecon (if you can tolerate his somewhat conceited attitude.)
SoberLook.com
