THE EU Commission has warned of significant risks to the rescue plan for Ireland’s banks, saying they may yet require additional capital if loan losses mount.

A day after the Government postponed the injection of €10 billion into AIB, Bank of Ireland and the EBS, the commission said in review of Ireland that unforeseen loan losses could undermine the assumptions made in the programme.

The commission’s review, one in a series of occasional papers by its economic staff, also warned of “considerable uncertainty” underlying the macroeconomic projections in the plan.

It said elevated spreads could persist for an extended period if the rescue programme was slow to restore market credibility, and said sentiment could worsen in light of adverse developments in other countries.

Stating that the election was imminent and many aspects of the programme have a legislative component requiring parliamentary approval, the review said the EU-IMF troika met the leaders of the main opposition parties when the plan was in preparation.

On the banking sector, the review cited the €10 billion recapitalisation plan to create large capital buffers and noted a further €25 billion would be available in case further unforeseen losses were to be revealed.

“In particular, such losses could be driven by the deleveraging process, which is expected to begin after completion of the prudential liquidity assessment review [for] 2011,” it said.

“Also, were the macroeconomic situation to worsen significantly beyond the scenarios envisaged under the stress tests, further pressures on banks’ asset quality and solvency could call for additional capital injections.”

However, the report said liquidity management exercises such as those at AIB and Bank of Ireland could be a strong mitigating factor reducing recapitalisation needs. “In addition, BOI is looking for external sources of capital to keep the bank majority private-owned.”

The commission also warned that deleveraging in the financial sector may be hampered by adverse market conditions, which could prevent asset sales.

New legislation on the question of burden-sharing by subordinated investors could affect the price of new bond issuances.

“The fiscal programme is robust to a slow improvement in market sentiment as the Irish sovereign does not need to access the sovereign bond market before end-2012, but stabilisation of spreads at a high level would negatively impact the private sector risk premium and economic growth, with repercussions on the budgetary position.”

The report also warned of implementation risks. “The planned reforms are substantial, will take a number of years, and engage a wide range of stakeholders both public and private.”

The commission acknowledged that economic growth could be lower than projected, especially in the near-term.

If inflation was lower than expected it would further support the competitive adjustment of the economy but add to the real burden of debt. This could have negative implications for households with high mortgage debt and other leveraged agents, as well as altering public debt dynamics,” the commission said.

“Domestic demand developments could be more unfavourable than projected if positive confidence effects only kick in very gradually or if lending activity remains subdued on account of slower-than-expected restructuring in the financial sector.

“Lower growth would inter alia lead to negative surprises regarding government revenue and expenditure. Moreover, in the highly leveraged Irish economy, further negative feedback loops between growth, the financial sector and the public finances cannot be excluded.”

With an export-led recovery being projected, growth prospects depend strongly on the outlook for Ireland’s main trading partners, Exchange rate developments, especially vis-à-vis the US and British currencies, were a further factor.

“While a deterioration in the outlook for the main trading partners would reduce the growth prospects of the very open Irish economy, cautious assumptions in conjunction with the volatility resulting from Ireland’s export structure imply that the external sector is also a possible source of upside risks.”