ANALYSIS:The key issue now is to agree on the methods and financial scale of recapitalisation, writes Arthur Beesley

BRIAN LENIHAN'S meeting today with the chiefs of the six State-guaranteed banks and building societies comes against the backdrop of a push by the fund management units of AIB, Irish Life Permanent and Bank of Ireland to recapitalise the banking system in concert with the Government and other long-term investors.

Although all investment allocations by AIB Investment Managers, Irish Life Investment Managers and Bank of Ireland Asset Managers are necessarily made independently of their parent institutions, their move in co-ordination with the Irish Association of Investment Managers (IAIM) stands as an implicit acknowledgement from within the banking system that the sector is now firmly in recapitalisation mode.

This was long resisted by the banks themselves. But the combined forces of domestic and international recession, the credit crunch, the precipitous collapse of Irish banking shares and the recapitalisation of international banks mean that the same fate now awaits the Irish banks.

The key issue now is to agree on the modalities and financial scale of the process, and to decide on who the participants are.

While Mr Lenihan maintains State investment is but a "last resort", Government sources acknowledge that some form of support from the public coffers seems increasingly likely.

Thus the IAIM's intervention two days ago served to widen the Minister's options considerably. In addition, it expands the range of choices available to the banks themselves.

If the arrival of the Mallabraca consortium and groups such as Texas Pacific and Kohlberg Kravis Roberts raised the spectre of a short-termist private-equity play on institutions integral to the performance of the Irish economy at large, the IAIM move demonstrates that major long-term investors are still in the game.

There is no small amount of self-interest involved here on the part of the fund managers in question.

Their existing investments in the banks - down drastically since the Irish market reached its height in February last year - would be significantly diluted by any recapitalisation from other quarters.

Whether the embryonic IAIM proposal proceeds to a full-scale plan will be seen in the coming weeks.

As efforts intensified yesterday to drum up support for the initiative from the international investment community, there were indications that the response was positive in the main.

But be it from this source or from the private equity world, the raising of new capital resolves only one part of the equation. Leaving aside the matter of how much money will actually be required to restore the institutions to long-term stability, questions loom over the banks' willingness to go along with a process of consolidation.

While it is difficult to foresee an independent future for the Educational Building Society and the Irish Nationwide Building Society, there are bigger questions around a possible fusion of Bank of Ireland and Irish Life Permanent.

Anglo Irish Bank, though often mooted as a consolidation target, remains determined to go it alone.

These are some of several issues for discussion today with the Minister, who has asked the banks to reflect on how they can execute the business plans they developed in light of the State guarantee.

Crucially, he also wants an update from the banks on their willingness to continue lending to the consumer and business markets. That becomes riskier as the recession bites, increasing the likelihood of loan impairments and writedowns.

The task of weathering such pressures in the face of the shutdown in international money markets makes recapitalisation all but inevitable at this point. Yet still more questions hang over the banks' ability to raise funding for their day-to-day operations. While it is a given that they must rebuild their balance sheets, the increasing deterioration in loan quality will only erode the new capital they raise.

In the short-term, this will serve to increase the cost of money-market funding.

In the medium term, the unwinding of the State guarantee in 22 months means the deadline for the resolution of all these issues is not very far away at all.

Whether the guarantee will have to be extended hangs in the balance. This will be a crucial issue for resolution as the recapitalisation endgame approaches.