THE European Central Bank (ECB) last night softened its stance on Ireland's plan not to pay more than €3.5bn worth of loans owed to investors by failed banks Anglo Irish and Irish Nationwide.
European sources said that if the debts owed by Anglo and Nationwide were to financial market speculators that buy companies in distress and not traditional bank investors there could be a case for easing rules against "burning the so-called bondholders".
Finance Minister Michael Noonan said on Wednesday that he did not want to fully repay €3.5bn of the safest type of debt owed by Anglo and Nationwide.
He is against paying off the debt because the two banks would have collapsed without government support and are being wound down.
A spokesman for the ECB declined to comment on the plan but it is understood that the ECB was caught off-guard by the news, which was not discussed with the bank in advance.
Until now, the ECB has been bitterly opposed to any move to impose losses on the safest types of debt owed by Irish banks.
The Frankfurt-based bank has opposed any move by any euro-area government to inflict loses on the safest types of bank borrowings.
That has been unpopular with taxpayers, but officials at the ECB think hitting lenders to banks with losses sets a dangerous precedent.
That would drive up the cost of finance for banks everywhere, hurting the flow of credit into the economy at time when the financial system is still weak.
Ireland cannot act against the lenders to the banks without winning support from the ECB, however, because the entire Irish banking system relies on the ECB for financial support.
Last night, an ECB official said he understood why Irish people resent paying off the debts of banks whose failures have cost the country so much.
"Everybody can understand in these particular cases why the Government would not want to spend €3bn paying off these bonds," the source said.
However, the same source said the ECB had to assess the impact its decisions have on the wider euro-area economy.
The source said the ECB thinks the type of institutions that hold the debt is more important than the fact that the two banks are being prepared to be shut down.
It means the ECB will want the Government to come up with a list of who really owns the bonds, and see evidence that the Government has engaged with them, before signing off on "burning the bonds".
Yesterday, Mr Noonan said that he wanted the matter on the agenda for talks with the ECB in the autumn.
The ECB is understood to see that timing as preferable to talking about the matter sooner.
Officials had been afraid that Ireland would try to make the issue the focus of a review of progress on the bailout that will happen in July.
The ECB has come under unprecedented pressure in recent weeks because Germany wants to inflict some pain on lenders to Greece.
But the ECB is resolutely opposed to that.
In the markets, Anglo Irish Bank bonds plunged yesterday, falling to around 74pc of face value when trading resumed for the first time after Mr Noonan's comments.
The debt of Bank of Ireland and Allied Irish Banks held up much better, however, with traders saying investors were distinguishing between the viable and non-viable Irish banks.
Meanwhile, the European Commission said it would also consider a plan to impose losses on holders of unguaranteed senior debt in Anglo Irish Bank and Irish Nationwide Building Society.
But a spokesman for the executive in Brussels said yesterday that it had received no advance notice of the plan either.