RBS' Stephen Hester ends the myth of bank capital being there to absorb losses

In this blog's discussion of the Japanese model for handling a bank solvency crisis, your humble blogger noted that the central element of this model is banks only recognize losses as they generate the capital to absorb them.

As a result, bank book capital is not available to absorb losses on the excesses in the financial system and save Main Street and the real economy.

Never did I expect to read an article in which a banker confirms a) that regulators have adopted the Japanese model and b) that there are losses hidden on and off his bank's balance sheet.

Mr Hester said [RBS], which is 83pc owned by the state, had been "spooked" by the severity of the eurozone crisis into taking "an extra £1bn" of losses for 2011. 

"We got spooked by the dangers of the eurozone so we deliberately spent an extra £1bn that we hadn't planned on in losses to go even faster than we had planned in reducing risk. 

"You can say to me it's a slight Alice in Wonderland world, where extra losses is a good thing and I completely appreciate the difficulty in the communication of that, but those are the facts," said Mr Hester. 

The RBS chief admitted that since its £45bn bailout in 2008, the lender had taken losses when it could "afford" to and used profits to "finesse" its results. 

"We have to finesse it with our own profits as we go through. Each year we have, in a sense, a budget for making losses for clean-up – and the better or worse our profits are, the better or worse that budget is and the faster or slower that we can go," said Mr Hester, adding that the bank had "never" had sufficient capital to recognise all its losses upfront.

Please re-read Mr. Hester's comments as they confirm the UK's adoption of the Japanese model for handling bank solvency and the simple fact that regulators do not use bank capital to absorb losses.