The Government has been advised to set up a 'toxic debt' company to take over billions of euro worth of bad property loans from the banks.
The Irish Independent has learned that leading economist Peter Bacon made the recommendation in a draft report.
It is understood the report has been submitted to Finance Minister Brian Lenihan.
Dr Bacon was brought in to advise the National Treasury Management Agency (NTMA) in February to look into the possibility of the Government establishing a 'bad bank' or risk insurance scheme to deal with mounting bad loans to property developers.
The economist is renowned for warning in a report on the housing market as far back as 2000 that "speculative demand" could lead to a "bubble".
It is expected that setting up a state-run 'toxic' assets management company would:
The Department of Finance declined to comment yesterday. However, government sources said the proposals were "tentative" and amounted to "scenario planning" and no decision had been made.
Critical to any deal would be that the banks sufficiently write down existing bad loans before transferring them to a new state-operated company.
It will be necessary to establish correct valuations for such assets to avoid perceptions of taxpayers having to foot the bill for rescuing the banking system. The draft report is believed to outline that the six main lenders covered by last September's guarantee scheme are sitting on about €60bn of property development loans.
But many of these are backed by commercial property -- office blocks, retail outlets and industrial units -- where outstanding lending is in the order of €100bn. Valuations have tumbled over the past 15 months.
Both areas would have to be addressed as part of an all-encompassing solution for the embattled banking system.
The main banks have been lobbying for the Government to set up an insurance scheme, similar to the UK, to protect them from excessive losses from bad loans.
However, Mr Lenihan recently told an Oireachtas committee that such a plan would amount to a time bomb for taxpayers -- leaving them with indefinite liabilities in the future.
Mr Lenihan said a 'bad bank' -- a solution similar to Dr Bacon's proposed asset management company -- would involve the State buying assets from banks at a substantial upfront cost.
Most commentators agree that the Government would find it virtually impossible to raise the necessary funding in the international market to buy the banks' toxic assets. However, one solution being mooted involves the proposed new company issuing government-backed debt to the banks in exchange for these assets.
The banks, in turn, would improve their own liquidity by having such government-guaranteed bonds on their balance sheets. And they would be required to hold far less capital in reserve for these 'AAA'-rated assets than for normal lending.
Allied Irish Banks, the country's biggest bank has indicated it expects to write off 22pc (€2.37bn) of its €10.8bn of Irish residential development loans in the three years to the end of 2010, but this could rise to 26pc (€2.8bn) in a worst-case scenario.
It expects to take a 9.5pc (€570m) hit against its €6bn Irish commercial development portfolio, but this could hit 12.3pc (€738m).
The bank believes it will be sufficiently capitalised to write off up to €8.5bn of bad loans -- mainly to property developers -- over three years as it continues to generate high levels of operating profits and avails of the government plan to put €3.5bn into its capital base.
However, the international markets -- rightly or wrongly -- have taken a view that AIB and other banks will not have enough capital without some sort of State intervention to draw a line under the problem.