Investor - An insider's guide to the market: In recent weeks the Irish banks have been active in tapping into the capital markets in order to bolster their capital bases.

Domestic and international regulators impose minimum capital ratios on financial institutions, below which they cannot go. Naturally, all financial institutions seek to operate above these minima in order to create a comfort zone to cater for unforeseen events. More importantly, just like any other business, financial institutions like to grow their business and to fund this growth they need to have some "excess" capital on their balance sheets.

The Irish financials are capitalised in line with international market norms, but despite this Irish banks have recently raised substantial amounts of new capital.

Anglo Irish Bank, possibly the fastest growing bank in Europe, sold 33 million new shares to raise in excess of €400 million. The new shares represented 5 per cent of shares in issue and the size of the placing was a record for the Irish equity market. It is estimated that the new capital will add approximately 1 per cent to Anglo's all-important tier one capital ratio - to bring it to an estimated 9.3 per cent by September 2006.

Bank of Ireland has also recently raised new capital by selling perpetual preferred securities, which are callable after 10 years. The Bank issued two tranches of $800 million (€662 million) and $400 million to raise just under €1 billion of new capital. The fresh capital is estimated to raise Bank of Ireland's tier one ratio to 7.6 per cent from 7.3 per cent by the end of March 2007.

Finally, at AIB there have been press reports that the bank is to enter a sale and leaseback transaction concerning its head office in Ballsbridge. Reports speculate that such a transaction would realise €360 million. Such a move would free up capital for AIB, but it would not be significant in the context of the overall group.

To understand why Irish banks are increasing their capital bases we need look no further than December house prices and lending data.

Growth in total credit was 28.8 per cent in December after an almost identical rise of 29 per cent in November. Mortgage and non-mortgage credit is now growing at a similar pace. Mortgage credit in December rose by a staggering €3.5 billion - the largest monthly increase on record. For 2005 total private sector credit grew by €59 billion, with net mortgage lending accounting for €21.1 billion. It is now clear that this acceleration in credit expansion in the fourth quarter was accompanied by an acceleration in the pace of house price inflation.

The Permanent TSB/ESRI index rose by 1.2 per cent in the month in December, the third month of strong growth in succession. Moreover, house price inflation clearly accelerated in the fourth quarter, and anecdotal evidence indicates that this momentum carried through into January.

Several economists are now forecasting house price inflation of the order of 10 per cent for 2006. Investor thinks that house prices are likely to rise by as much as 15 per cent in 2006, due to the heady cocktail of strong economic and employment growth, ballooning credit growth and the SSIA feel-good factor.

Irish financial stocks are clear beneficiaries of the buoyant housing market and Investor expects them to perform well in 2006. This is in spite of ongoing intensification of competitive pressures. An example of this is the range of new mortgage products being launched by Bank of Scotland. In particular their "switcher" product looks very attractive and is designed to directly attack the existing mortgage books of the incumbent banks. This particular product offers a deeply discounted interest rate over the first two years and a subsidy of €1,000 towards legal fees.

Higher short-term interest rates also pose another threat to the current rosy scenario. A rise in the ECB policy rate to 2.75 per cent is now fully priced into capital markets and consumers' expectations.

Short-term rates at 3 per cent would probably not have an appreciable negative impact on demand. Although if rates were to rise substantially above 3 per cent it would probably slow the current pace of growth.

While Investor recognises the medium-term risks posed by the current rapid rate of credit growth, it is the shorter-term benefits of this growth on profitability that will be at the forefront of investors minds for at least the first half of the year.

Therefore, if the international background remains benign there is significant upside to the current share prices of Irish financials.