IMF urges banks recognize losses on excess debt to spur economic growth

Reuters reports that the IMF's first deputy managing director, David Lipton, is urging that banks be required to recognize their losses on excess debt in order to spur economic growth.

Regular readers recognize that this is an endorsement of your humble blogger's Swedish Model for handling a bank solvency led financial crisis.

Under the Swedish Model, banks recognize upfront their losses on the excess debt in the financial system.  This protects the real economy by not diverting capital needed for growth and reinvestment to making the debt service payments on this excess debt.

Because of how a modern banking system is designed, the banks do not have to be recapitalized today for the losses they recognize.  Instead, banks can be recapitalized gradually going forward through retention of 100% of pre-banker bonus earnings.

Banks can be gradually recapitalized because of the combination of deposit insurance and access to central bank funding.  Deposit insurance effectively makes the taxpayers the banks' silent equity partners while they have low or negative book capital levels.  As a result, it is as if the banks have infinite capital and they can continue to originate credit as needed to support the real economy.

Global economic conditions remain subdued despite a recent rally in financial markets and policymakers need to act to address underlying stability risks, including dealing with weak banks, a top IMF official said on Tuesday. 

David Lipton, the International Monetary Fund's first deputy managing director, said... 

"Banks will need to remove the dead wood and address asset quality problems, with some having to increase provisioning for bad loans and add fresh capital," Lipton said in prepared remarks to the Chartered Financial Analyst Society. 

"Some banks will prove to be non-viable and will need to be wound down in an orderly manner," he added.

The definition of a non-viable bank is a bank that does not have a franchise that allows it to generate earnings pre-banker bonuses and therefore cannot internally generate the capital to rebuild its book equity levels.