DUBLIN (Reuters) - Irish banks' reliance on European Central Bank (ECB) funds eased last month, but they could remain locked out of interbank lending markets if the likely new government imposes losses on banks' unsecured senior debt, rating agency Moody's warned.
As public discontent has grown over the costs of an 85 billion euro EU/IMF bailout Ireland took last year to rescue the banking sector, opposition parties on the verge of power have argued that some of the pain should be borne by banks' senior debtholders not covered by government guarantees.
As the struggling banks lost access to the interbank markets, their dependence on the ECB has grown massively in recent months, with lenders' funding from that source up 50 percent in the second half of 2010.
That reliance eased slightly for the second month running, with 126 billion euros (£107 billion) borrowed as of January 28, compared with 132 billion euros at the end of December, data showed on Friday.
Ireland's central bank has increased its special funding to counter the outflow of corporate deposits. Its lending stood at 51.1 billion euros in special funding as of January 28, the same amount it had lent by December 31.
After downgrading the unguaranteed senior unsecured debt ratings of six Irish banks earlier on Friday, Moody's said plans by Ireland's likely new government to try and share losses with senior creditors would make it harder to wean banks off support.
"The banks are hugely reliant on central bank funding, and that's not going to go away anytime soon. By potentially burden-sharing with senior debt holders, you are obviously potentially putting back the ability of banks to fund again in the market," Ross Abercromby, Moody's lead Irish banking analyst, told Reuters.
Ireland's main opposition parties, the centre-right Fine Gael and centre-left Labour, are expected to form a new coalition after a February 25 election and want to be allowed to impose losses on senior bondholders not covered by an Irish guarantee.
The parties are trying to reduce the burden on taxpayers, who have already forked out more than 46 billion euros in capital for the banks and face years of cutbacks and tax increases to help pay for a disastrous property crash.
Moody's cut the senior unsecured debt rating of Allied Irish Banks to Ba2 from Baa3, Bank of Ireland to Ba1 from Baa2, EBS Building Society to Ba2 from Baa3 and bancassurer Irish Life & Permanent.
It cut the ratings of state-run Anglo Irish Bank and Irish Nationwide Building Society -- whose deposits and assets began to be auctioned off by the state this week -- to Caa1 from Baa3.
The central bank did not give a breakdown of borrowing between domestic banks and foreign banks based in Ireland, but last month it said domestic lenders accounted for 72 percent of ECB borrowings in December, up 2 percent on the previous month.
Moody's kept the ratings of all six domestic banks under review for further possible downgrade and said if the risk for senior creditors increased significantly, the ratings would likely face further multi-notch downgrades.
Ireland's finance minister also said this week Ireland was pressing its European partners to allow it to substantially discount unguaranteed senior bank debt, but he could not see the European Central Bank (ECB) contemplating such a move.
Moody's said Finance Minister Brian Lenihan's announcement on Wednesday of a postponement of further capital injections into Bank of Ireland, Allied Irish Banks and EBS until after the poll added to its concerns.
Fine Gael, expected to lead the next government, said a new administration should wait until after the central bank completes a fresh round of stress tests at the end of March before putting more capital into lenders.
Labour's finance spokeswoman agreed on Friday, but her leader Eamon Gilmore went a step further and was quoted by The Irish Times as saying his party would not put any further capital into the banks until Ireland's IMF/EU bailout is renegotiated.
(Additional reporting by Kate Holton, Editing by David Holmes and Will Waterman)