MINISTER FOR Finance Brian Lenihan has signalled in discussions with the six guaranteed banks and building societies that he expects mergers to take place to strengthen the Irish banking sector in a move that could dramatically reshape the industry.

Mr Lenihan met the heads of the six institutions yesterday amid growing speculation that the banks would be recapitalised in a scheme that could involve multi-billion euro cash investments by foreign private equity firms.

The recapitalisation, which could involve co-investments by the State, is expected to take place in tandem with consolidation in the sector that may eventually lead to two enlarged banks based around the biggest players in the market - AIB and Bank of Ireland.

The smaller institutions are likely to resist attempts to be "shoe-horned" into mergers with larger banks that would lead to a duopoly and reduced competition.

The Minister met Irish Life Permanent chief executive Denis Casey and chairwoman Gillian Bowler; EBS chief executive Fergus Murphy and chairman Mark Moran; and Irish Nationwide chief executive Michael Fingleton and chairman Michael Walsh, in meetings at Farmleigh in the Phoenix Park yesterday.

Yesterday evening, Mr Lenihan met AIB chief executive Eugene Sheehy and chairman Dermot Gleeson, Bank of Ireland chief executive Brian Goggin and governor Richard Burrows; and Anglo Irish Bank chief executive David Drumm and chairman Seán Fitzpatrick in further meetings.

Asked at the publication of the Finance Bill whether his discussions would result in consolidation in the sector, Mr Lenihan said: "I am not going into issues which are currently under discussion." Later he said: "The public should be assured that the Government is determined to continue efforts to stabilise and reform the banking sector to ensure it provides credit for Irish small and medium-sized enterprises as well as consumers."

The talks took place as it emerged that a consortium of private equity firms, including US companies JC Flowers and the Carlyle Group, had expressed an interest to Government in investing cash in return for a stake in Bank of Ireland and possibly a merged entity joining the bank with Irish Life Permanent.

The banks had no comment.

The consortium, named Maulabracka, is being led by Nick Corcoran and Nigel McDermott of Dublin firm Cardinal Asset Management. It's not clear how the Government views the overture, though talks have taken place.

A Department of Finance spokesman declined to comment.

Mr Lenihan declined to comment on the likely outcome of his discussions with the banks.

"The structured dialogue has to be constructive it has the purpose to ensure that there is ample credit available in the Irish economy," he added.

Mr Lenihan made his comments as the six institutions submitted revised business plans to the Financial Regulator showing how they intend to reduce risks facing them under the two-year guarantee to ensure the insurance policy would not be called upon.

AIB became the first Irish bank to raise funding selling two-year Government-insured bonds using the guarantee for the first time.

The bank raised €2 billion from 125 investors in the debt issue, paying 0.55 per cent over the mid-spread rate - the base cost on which bonds are priced. This is 10 times the spread paid by France last week for three-year funding for loans to the country's banks.

A spokesman for the bank said: "We're very satisfied with how well the deal has been received. We had orders for €3.9 billion. We took €2 billion and we've left plenty of demand out there for the other Irish banks."