There is still some debate out there about how Eurozone's TARGET2 imbalances increased so much last month. The answer is simple. The national central banks (NCBs) in the periphery used TARGET2 to plug the holes in their balance sheets generated by the second 3-year LTRO. We saw that the Bank of Spain plugged a €55bn hole with TARGET2. Bank of Italy did the same but their portion was materially larger. Not only did Bank of Italy have to fund the LTRO (to the tune of about €127bn), but the central bank also had a reduction in deposits from the government and a drop in bank reserves (another €10bn). That's about a €137bn hit to the balance sheet and here is how this outflow was "funded".
|How Bank of Italy "funded" LTRO-II (€127bn), and other outflows (€10bn)|
TARGET2 balance sheet plug for March alone represented €76bn, bringing the total "Other liabilities within the Eurosystem (net)" to €270bn - a bit of an increase from the last time we looked at Bank of Italy (when this number was €194bn).
On a combined basis Bank of Italy and Bank of Spain have plugged a €131bn balance sheet gap in March. Note that when the NCBs "borrow" from the Eurosystem, they do not post collateral (they hold on to the collateral that banks post to them under LTRO). There is a reason that the Germans are concerned.
For further detail, please see Bank of Italy Balance Sheet (end of March 2012)