RATING AGENCY Fitch has said it expects the Government guarantee scheme to be extended by the European Commission in December 2010 as Irish banks are likely to continue to need the scheme to attract funding after this date.

The guarantee scheme was introduced in September 2008, covering some €400 billion of bank liabilities. The scheme was scheduled to lapse on September 29th this year but last month the commission extended it until the end of this year.

Unlike the original guarantee scheme, the extension does not include subordinated debt, a secondary form of debt which carries a risk premium. The decision to include subordinated debt in the original scheme was sharply criticised by the Opposition.

A decision on whether to seek a further extension in December has not yet been made by the Department of Finance.

A department spokesman said yesterday that the department has welcomed the extension of the eligible liabilities guarantee until December 2010 and would continue to monitor the situation.

In its semi-annual review of Irish banks, Fitch states that funding is “the most important challenge facing Irish banks” but that it is “manageable”.

It said the fact that Allied Irish Banks and Bank of Ireland had passed the recent stress tests suggests investor confidence has improved towards the banks, which if maintained may improve the banks’ access to funding.

However, the report makes a distinction between Bank of Ireland and AIB.

It says it expects impaired loans to continue to dent the reported operating profits of the institutions, but that “a polarisation” will occur, with certain institutions, including Bank of Ireland, set to return more speedily to a more normalised performance. Others, such as Allied Irish Banks and Anglo Irish Bank, are likely to take longer to successfully implement their restructuring.

Fitch said the ending of the original scheme in September has created some uncertainty as to how the banks will cope. The extension of a lesser guarantee scheme should help issuers when the market becomes easier to access, the report says. But the higher cost of this funding and an increase in the cost of ECB funding will weigh on revenues.

While broadly welcoming Nama, the report states that the substantial losses expected on the sale of loans to Nama will erode a material portion of capital, while restructuring charges are likely to further depress pretax profit at the banks.

The agency predicts a “significantly better, if still muted” performance by the banks in 2011, due to a gradual improvement in the economy, a reduction in loan impairment charges and the absence of losses on the sale of loans to Nama.