Well the debate over Target2 balances has been off the radar for a while now. However, the quest to figure the balances and other details remains with this blog. It was just an amazing learning to know abt the monetary flows in Euroarea.
A nice paper by Bank of Italy econs on basics of Target2 balances. They also say the same thing. Target 2 balances rose as a response to drying up of interbank market in Euroarea. Barring Greece
The paper analyzes developments in TARGET2 imbalances within the euro area since 2007, from two perspectives: national central banks’ balance sheets and countries’ balance of payments (BoP). We examine the relationship between TARGET2 balances and the Eurosystem liquidity provision, analyzing how the circulation of the latter has changed during the crisis. We then study BoP developments in Greece, Portugal, Italy and Spain, investigating which of the following explanations accounts for the growing TARGET2 imbalances: (i) current account deficit, (ii) decrease of net inflows of private capital from securities and interbank markets and (iii) run on deposits.
The results of our analysis suggest that while the increase in TARGET2 liabilities is related to the current account deficit in Greece, there is no evidence of this in Italy, Spain and Portugal. In all countries the increase is mostly driven by private capital outflows in securities and interbank markets; deposit runs are apparent only in Greece. In Italy, the reduction of capital inflows consisted entirely in a decrease in the interbank market cross-border activity and in portfolio investments by non-residents.