Italy Funding Panic? Target2 Liabilities Unexpectedly Soar To Record High

During the peak days of the European credit crisis in 2011 and 2012, one of the unfalsifiable indicators used by market watchers to observe the state of Italy's banking system and regional fund flows (mostly outflows from the periphery, inflows into Germany and northern states), was the monthly Target2 balance. Positions within the Target2 system, which settles cross-border payments in the euro zone, are monitored because in a world where all other market signals are corrupt and distorted by central banks (Spanish 10Y bonds yield less than US bonds), they remain a reliable, concurent indicator of financial stress, for example when banks in a country lose foreign funding.

Which is why we were surprised to learn that in the latest monthly update, Bank of Italy's liabilities toward other eurozone nation soared by €35 billion in August, just shy of the biggest monthly increase on record, and reached an all time high of €327 billion, surpassing the previous records set in 2012, just prior to Draghi's infamous "whatever it takes" speech.

 

What makes the surge in liabilties particularly notable is that Italy continues to sport a healthy current account surplus, suggesting the source of the outflows is likely found inside Italy's banking sector. In July, the Bank of Italy said that the recent increase in its Target 2 position was driven by foreigners selling Italian assets, especially bonds, and Italians buying foreign assets, movements which were only partially offset by Italian banks raising more funds on international markets.

In August this trend accelerated dramatically, prompting questions just how dire is the true state of Italy's banks, behind the shiny and cheerful facade presented on a daily day by Matteo Renzi, and whether this has anything to do with the recent decision by Milan prosecutors to end the probe for market manipulation, false accounting and corruption by insolvent Monte Paschi's CEO and former chairman which "risked undermining investor sentiment."