Finance Minister Michael Noonan has told Bank of Ireland it must raise €4.2bn by mid-June or it will be nationalised in the same way as AIB.
Mr Noonan said Bank of Ireland has indicated that it can access private funds instead of taking the €4.2bn the stress tests signalled that it needs and is in negotiations with senior bond holders about providing some or all of this money.
"If it is successful, then it will continue to be a public company, but if it doesn't, the State will own Bank of Ireland as it owns AIB," he said yesterday.
Meanwhile, as part of the Government's restructuring plan for the banking sector, Mr Noonan said that Irish Life & Permanent's management have been given two weeks to present him with a plan for how it will dispose of its life business and downsize its operations.
The group needs €4bn to survive as a bank once it has sold off its non-banking assets. Mr Noonan said the splitting of the group was necessary because there was a risk its impaired banking arm, Permanent TSB, would damage its insurance company, which he said was "sound and solvent." If the bank was unable to raise money independently, the Government would inject the €4bn and take a significant majority shareholding in it, Mr Noonan said.
After that it would either continue to trade as a small niche bank that will take deposits and give out mortgages. In the longer term it could be taken over by another institution.
The €150bn lent by banks outside the State will be the prime target of the Government's plan to shrink the size of Irish banks by a third.
Many of the loans were to fund property purchases from Britain to Bulgaria, finance officials said. Property loans, especially aboard, will have to be wound down to make more room for lending in the domestic economy.
The Government will also be hoping it won't have to take both Bank of Ireland and Irish Life & Permanent into State control along with AIB.
That bank is to be merged with EBS and it, together with Bank of Ireland, will create two strong Irish banks providing services for Irish customers.
Under the plan, the Government is leaving it up to foreign banks, such as Ulster Bank and National Irish Bank, to provide competition for consumers.
Mr Noonan also announced that AIB and Bank of Ireland would be charged with making €12bn worth of loans available to Irish small and medium businesses, which have been starved of cash for a couple of years.