Funding costs for the Irish banks are set to double and possibly triple, with AIB and Bank of Ireland unable to pass on the higher costs to customers, a report from Barclays Capital warns.
The London-based bank said it was "wary" of Irish banks with AIB's average funding costs to rise from 3.3pc to 5.8pc, and Bank of Ireland's to rise from 2pc to 5.8pc.
The influence of the Government on the two banks means neither will be able to fully pass on higher funding costs, the Barclays report claimed.
"Given the high level of government support it has received, we do not expect AIB to be in a position to pass on higher funding costs to customers," according to the report.
In relation to Bank of Ireland, Barclays said the likelihood of the bank passing on the higher costs, via higher rates on mortgages, was "limited".
According to the report, which circulated in London yesterday, AIB will still need to raise €2.1bn in fresh capital if it sells its Polish and US businesses. "In the current environment, we would not attach much value to this," Barclays said of AIB's plan to sell its overseas assets.
The comments are included in a report on 20 major European banks. According to a survey of the banks, Bank of Ireland would have the highest funding costs in Europe once it starts raising fresh wholesale funding. According to Barclays, AIB and BoI are both facing major challenges despite recent attempts by the Government to stabilise the system. They will both have to raise huge amounts of capital even after Nama has removed their most toxic loans.
AIB will have to raise 603pc of its market value, with Bank of Ireland needing to raise 348pc of its current market worth.
However, the report says both banks are "too big to fail" and predicts that they will continue to get government support if the private sector does not come forward.
The banks are faced with a simple choice, said Barclays, of either cutting back on the amount they lend or taking in more deposits. But with the Irish deposit market so small, this is going to be difficult.
AIB will either have to shrink its loan book by 34pc or boost its deposits by 52pc. Bank of Ireland will have to reduce its loan book by 35pc or bolster its deposits by 53pc.
The report said Bank of Ireland could end up with a government stake of over 50pc, leaving current shareholders massively diluted.