Bank of England's Mervyn King calls for EU banks recognize losses

The Telegraph reports that Sir Mervyn King observed that

banks across Europe urgently need a "major recapitalisation" to rebuild their solvency buffers, help ease the eurozone crisis, and kick-start the recovery.... 

Sir Mervyn King claimed Europe's leaders are failing to deal with a core problem at the heart of the crisis – the weakness of the region's banks, not just those in Spain that are to receive a €100bn (£80bn) bail-out.... 

Sir Mervyn said that the problem with Europe's lenders was "one of solvency". He added: "Until losses are recognised, and reflected in balance sheets, the current problems will drag on. An honest recognition of those losses would require a major recapitalisation of the European banking system."...

Please re-read the highlighted text as he has called for EU policymakers and regulators to drop the Japanese model and adopt the Swedish model for handling a bank solvency led financial crisis.

Under the Swedish model, banks are required to recognize the losses on and off their balance sheets today.  Doing this eliminates the drag on the real economy caused by the excesses in the financial system.  With the drag removed, the economy resumes growing.

Since the size of the losses to be taken is substantial, it is going to require a major recapitalization of the EU banking system.

Fortunately, the EU has a modern banking system with deposit guarantees and access to central bank funding.  As a result, the banks can continue to operate and support the real economy for several years while they are retaining 100% of pre-banker bonus earnings to rebuild their book capital levels.

However, the Governor stressed that funding problems at both UK and eurozone banks were "a reflection of insufficient capital" and he urged them to build up their buffers as rapidly as possible. "That is why the [Bank] has encouraged banks to find additional capital to increase their resilience to such losses, so reducing funding costs and increasing their ability to lend to the real economy," he said.

The funding problems at both UK and EU banks is a reflection of banks being 'black boxes' and not a reflection of insufficient capital.

As the OECD said, bank capital figures are meaningless.  Regulatory forbearance since the beginning of the financial crisis inflates both asset values and bank book capital levels.

The market, particularly the banks, recognizes this.  That is why the interbank lending market is essentially frozen.  Banks cannot determine who is solvent and who is not solvent.

Despite the repeated demand for more capital, Sir Mervyn took some regulatory pressure off the sector by suggesting lenders did not need to hoard so much unprofitable liquidity – such as cash or gilts – to protect against a run. "Where central banks stand ready to provide extraordinary amounts of liquidity, the need for banks to hold large liquid asset buffers is much diminished, and I hope regulators around the world will take note," he said.

This is the role for the central banks after the banks have recognized all their losses and while they are rebuilding their book capital levels.