Target 2

Target is short for Trans-European Automated Real-time Gross Settlement ExpressTransfer System. It's a payment system used by Europe's central banks for urgent real-time electronic transfers.

In terms of the value of payments processed, it is one of the biggest such systems in the world. Its behind-the-scenes work ensures that people and businesses across the eurozone can settle (make and receive payments on the date expected and to the account expected) reliably.

As such it plays a key role in the smooth functioning of Europe's banking system and economy. So why is it in the spotlight now? As a successful exporter, Germany has over the years built up a current account (trading) surplus and been able to lend money to southern European countries running deficits. Now, though, much of that capital is fleeing back to Germany as investors worry about the health of southern Europe.

The European Central Bank has stepped into the void left by foreign investors pulling out of risky countries by lending their banks more money at a cheap rate. And the central bank that is effectively doing the lending is Germany's Bundesbank. It in turn gets the funds it is lending by borrowing them from Germany's commercial banks.

Target2 balances between the 17 national central banks within the eurozone reflect how the extra cheap money has been allocated. The overall result is that the Bundesbank has a large Target2 receivable balance (an asset) and the equivalent national central banks in Spain and Italy have large payable balances (liabilities).

How long this can continue is a function of two factors how much acceptable collateral southern European banks can muster to support their extra loans and the speed and scale of the capital flight from them.

Watch Tim Bennett's video tutorial: What is Target 2?