[Balanor]

Not sure I'm entirely following all the question, but I'll try to explain and if you need more clarification, post again.

As I understand it though the way the NWN engine works, you may as well spend the XP that is banked that would put you above 16th lvl. As when you lvl do you not loose the xp beyond what the requirement was normaly?

With this system, you will not lose any XP even when leveling up, even if you have more than what is needed to reach a level to which a PC may have just leveled-up. For example, if a PC had 190K XP before this, and they attain the notoriety necessary to level up to level 16, they still have 190K XP even after the level 16 level-up. This is assuming that they didn't use any of that banked XP for enchantment forge enhancements or returning from the Fugue, or losing some in other ways.

...so some one who just lost 5 lvls could in theory if they never spent any XP get right back as long as they gained the necessary notoriety?

Yes, this is exactly correct.

A person might already even have that requirement to gain back much of what was lost, since if you already are at a faction ranking of 5 then any notoriety you've gained has just been piling up correct?

There have been additional notoriety levels added above even that required to reach the top faction ranks, and those are what must be reached to attain level 16+.
Edit: Right now there are people close to the new notoriety level who had notoriety maxed out for their PC in the previous system, but even they will need to work a little more to cross the threshold of the next notoriety level required for level 16.