Dublin - Ireland put a €70bn price on protecting its banks from future shocks on Thursday and promised a radical overhaul of the sector, trying to persuade investors it has the nation's financial crisis under control.
The European Central Bank (ECB) offered a compromise funding solution for Irish lenders. However, its proposal fell short of a formal medium-term funding facility that would have gold-plated Dublin's big bang announcement.
Ireland's central bank said fresh stress tests showed the country's four remaining lenders needed to recapitalise to the tune of €24bn, in line with expectations.
That comes on top of the €46bn taxpayers have already poured into the sector, giving a total bill equal to $100bn.
"The cost is huge," Finance Minister Michael Noonan told parliament. "(But) the price will be worth paying if we get a functioning banking system."
Under a restructuring of the sector, two "pillar" banks will be left, and all lenders will be either nationalised or majority owned by the state.
Investors are sceptical that Ireland, still struggling to emerge from the worst recession in the industrialised world and a recipient of a European Union/International Monetary Fund bailout last year, can handle one of the world's costliest banking crises.
Noonan admitted the stakes were still high and much depended on the overall economy. "If growth crashes, we are all in trouble in this country," he said.
Europe's debt crisis is spreading to its banks as sovereign rating downgrades hit countries' ability to access credit markets, pushing them into the arms of the ECB which is the lender of last resort.
The ECB said in a statement it would continue to accept Irish sovereign debt as collateral, regardless of its credit rating, and promised the banks continued access to liquidity.
This fell well short of a medium-term funding facility for lenders which had been expected, but it should give some comfort that Irish banks' near €160bn in funding from the ECB and the Irish central bank remains intact.
"It's a compromise solution that probably eases some of the most pressing concerns," said Austin Hughes, chief economist at KBC Bank. "The critical element will be how the rating agencies deem this support."
Internal disagreements within the ECB Governing Council torpedoed the medium-term facility, eurozone official sources told Reuters.
Standard & Poor's has already warned it could strip Ireland of its A- rating after the results of the bank recapitalisation plan.
The agency downgraded Portugal to one notch above junk to BBB- this week and a cut to its banks followed on Thursday, raising the heat on Lisbon which is widely expected to follow Greece and Ireland into an EU aid programme.
A restructuring conversation
Ireland's debt as a proportion of its gross domestic product (GDP) output will hit 111% in 2013 from close to 100% currently if the state has to pump the full €24bn into the banks.
Noonan said he hoped between €5bn and €6bn could be raised through imposing losses on holders of subordinated bank debt and a couple of billion more through private capital.
Bank of Ireland was working on a plan to raise capital privately and Irish Life & Permanent is to sell its life and pensions and investment management businesses.
Noonan dropped a previous threat to impose losses on senior unsecured bonds in Bank of Ireland and Allied Irish Bank, which will form the core of the new financial system.
"If you are constructing two new banking pillars for the economy you probably don't want to penalise people that the banks in future may be relying on to fund them," Noonan said.
But he said Dublin would consider imposing losses on such bondholders in nationalised Anglo Irish Bank, if that lender required more capital on top of the €29bn it has already swallowed.
The ECB is opposed to hitting any senior bonds in banks because of the risk that investors would panic that similar moves could be carried out in other eurozone countries.
Senior debt ranks equally in law with bank deposits, which Ireland guaranteed during the 2008 crisis. However, subordinated debt is a more risky investment and any losses for its holders should inflict less of a market shock.
But analysts said Dublin could yet have to tap AIB and Bank of Ireland's €11bn of senior unsecured bonds.
"It is going to be very, very difficult for those banks to raise the capital required and at some point a restructuring conversation needs to happen," said Michael Hewson, market analyst at CMC Markets in London.
Ireland's central bank said the four commercial banks would be required to maintain a minimum capital ratio of 6% under a stress test aiming to show they could withstand potential losses from a worsening economy.
Under the stressed scenario AIB needs €13.3bn, Bank of Ireland €5.2bn, EBS building society €1.5bn and Irish Life & Permanent €4bn.
The government plans to merge AIB with EBS to form one pillar of its banking sector with Bank of Ireland the second.
Under the restructuring plans Ireland's banks will have to deleverage huge sums. Bank of Ireland will have to shed €30bn of assets by 2013 while AIB and EBS combined will have to shed €23bn of assets by 2013.