IRISH SITUATIONThe Financial Regulator, while remaining vigilant, has set out to assure us that Irish banks can weather this storm, writes Simon Carswell

THE SPECTACULAR rescues of insurance giant AIG, investment bank Merrill Lynch and the UK's biggest mortgage lender, HBOS, earlier this week raise the question of whether any Irish bank is also too big to be allowed to fail and too crucial to the economy.

The question, of course, presupposes that any Irish financial institution is facing potential collapse.

While Irish banks face rising bad debts amid a declining property market and higher funding costs like all global banks, they are solid and well-capitalised.

Assurances have been given by the Irish Financial Services Regulator Authority that the Irish banks are robust and can weather the storm. It also says they have very few investments in the kind of assets that have felled some of the towering giants of Wall Street.

Pat Neary, chief executive of the regulator, said on Wednesday that regulatory changes and new liquidity requirements introduced before the crisis last year left Irish banks "in a position to benefit from a solid base when the turmoil hit". He added that Irish banks had little exposure to the toxic investments that sparked the crisis and sank Lehman.

"Irish banks have only very limited exposures to US subprime losses and related structured credit products," he said. "Irish banks are resilient and have good shock-absorption capacity to cope with the current situation."

The regulator, however, was more vigilant of the Irish banks and continued "to remain on high alert" to any emerging risks.

It has sought updates every evening this week from the banks on flows of customer deposits to monitor any dramatic changes in response to the developments in the US and British financial sectors. Irish banks have also been queried by the regulator about any exposure to AIG and Lehman.

AIG, one of the world's biggest insurers, has tentacles in businesses around the globe and its collapse would have rocked the international financial system, convincing the US government it could not allow the insurer to fail.

Despite being initially reluctant to use taxpayers' money to save AIG, the US Federal Reserve stepped in with an $85 billion (€59 billion) bailout when the private sector refused to support the firm following downgrades in its debt ratings, making it more difficult to raise money.

The failure of US mortgage financiers Fannie Mae and Freddie Mac, which own or guarantee almost half the $12 trillion US home loans, would also have been unthinkable and, in the eyes of the US government and the Fed, they were too important to crumble.

In Britain, the government and prime minister Gordon Brown appeared to encourage this week's £12 billion (€15 billion) all-stock shotgun merger between Lloyds TSB and HBOS, while US regulators pressed Merrill Lynch to embrace the clutches of Bank of America and avoid the fate that befell rival US investment bank Lehmans, which collapsed with debts of $613 billion.

Credit-rating agencies Moody's and Fitch have said in recent months that they believe there is a reasonable chance of the Government supporting the main Irish banks in the event of them suffering severe financial difficulties.

The agencies have told debt investors in the three main banks - AIB, Bank of Ireland and Anglo Irish Bank - that in the event of a collapse, the Government is likely to step in to prevent a systemic risk to the Irish financial system.

Moody's said in a report last April that its high Aa2 deposit rating for Bank of Ireland was due to the agency's "assessment of a very high probability of systemic support in the event of a stress situation", as it ranked Ireland as "a medium-support country" in terms of the likelihood of the State supporting its financial institutions.

Fitch affirmed Anglo's A strength and support ratings this month, saying they reflected "the moderate probability of support from the Irish authorities should it ever be required". The agency said the rating showed the bank's consistently strong performance, good asset quality and low costs.

Even a moderate likelihood of a State bailout helps improve ratings on financial institutions and allows them to borrow from investors and in money markets at lower rates.

Assigning a rating three levels below its top grade on deposits at Bank of Scotland (Ireland) two weeks ago, Moody's said it reflected "the high probability of systemic support", believing the State would protect even this foreign-owned bank.

Stuart Draper, stockbroking director at Dolmen Securities, said the Government would certainly support the main banks if they faced failure. "It's very much a hypothetical situation at the moment," he added. "None of the four main Irish banks will go the way of Northern Rock or Lehman Brothers. There is zero risk to any Irish deposit holder."