OPINION: ONE OF the more prudent property developers of recent years suggested privately in conversation that most of the problem loans weighing on the banks' books could be blamed on just 20 men.

It’s an interesting thesis and not without some foundation, particularly given the finding in the recent PricewaterhouseCoopers report into Anglo Irish Bank that its top 15 borrowers each owed at least €500 million and that the top 20 customers owed €11.4 billion or 26 per cent of the Irish loan book.

There’s no doubt that the banks have a heavy concentration of development loans – estimated at €60 billion across the six guaranteed Irish lenders – among a small number of borrowers. This is a case of having too many eggs in a basket that has quickly unravelled.

Eugene Sheehy, chief executive of Allied Irish Banks (AIB), the lender with the heaviest exposure to the building sector, has said that up to five developer customers each owe more than €500 million.

These development loans are the contaminated assets that the Government has to address in part three of its drawn-out plan to fix the beleaguered banking sector.

First, there was the emergency guarantee last September, and then the recapitalisation of AIB and Bank of Ireland, and the nationalisation of Anglo Irish.

Next up is the creation of a bad bank, which, in the Irish context of a property crash, involves transferring problem loans to a toxic or “asset management agency” run from the National Treasury Management Agency (NTMA).

This is the preferred option of Minister for Finance Brian Lenihan. The aim is to draw a line under the banks’ rising bad debts, primarily on development loans, that have increased in recent months so the banks can lend more freely.

The belief is that, by removing toxic loans, the banks won’t have to keep increasing the estimates for bad debts or hoard capital. By increasing the flow of credit the Government will try to ensure businesses can borrow, making the recession less prolonged.

Analysts at Credit Suisse estimated – after being briefed by Lenihan during his St Patrick’s Day mission to London – that up to 60 per cent of the projected bad debts at AIB and Bank of Ireland relate to property and construction, and that the two banks will have to place a combined €36 billion of loans into the toxic company.

All this confirms the long and widely held conclusion that developers and excessive bank lending caused the Irish banking crisis.

One of the State’s most prolific developers, Paddy Kelly, told the Commercial Court last week that he was considering filing for bankruptcy and confirmed in a Sunday Times report yesterday that he owed Anglo Irish €700 million.

Kelly’s predicament, as an example, makes the creation of a toxic firm all the more pressing. While unpalatable to taxpayers, a toxic property company essentially means the nationalisation of the riskiest parts of the sector.

But moving toxic loans could also reduce the mounting risks faced by the taxpayer from last year’s €440 billion guarantee.

It is anticipated that transferring the problem loans will leave behind “good” banks where the State’s capital injections are protected and investors will be better able to judge the future risks.

But there is a large minefield to cross before reaching safety.

The challenge is in assigning a value to the toxic property loans to be transferred to the toxic firm. If the Government sets the price to the banks too high – assuming much sharper falls in the property values than even the banks’ worst-case estimates – this will mean much higher loan losses up-front.

This will deplete capital reserves and could force the Government to inject more taxpayers’ money.

In turn, that would necessitate greater State ownership of the banking sector and would show up the Government’s two previous recapitalisation plans as being inadequate.

Set the price too low and the transfers will not remove all the problem loans, leaving the banks still encumbered with toxic assets.

Peter Bacon, the economist hired by Government to devise a bad bank tailored for the Irish property crash, is pushing for the toxic firm, but his view of the real value of property is pessimistic, in some cases gloomier than the banks’ own gloomiest forecasts.

This will put increasing pressure on senior bank executives to, yet again, revisit their worst-case scenarios and accept that their previous estimates were wrong. Such an exercise could (or at least should) force more resignations at senior executive levels within the banks.

The creation of a Swedish bad bank in 1992, which helped reconstruct that country’s collapsed banking industry, has been held up as a model to be followed.

However, the big difference is that Sweden’s banking system had been largely nationalised and that many of the banks’ loans had already been heavily written off.

Another obstacle is how to address the problem loans at Ulster Bank and Bank of Scotland (Ireland), whose parent banks are participating in the British government’s risk insurance plan.

This scheme involves writing off loan losses over time rather than up-front in a bad bank scheme.

Many Irish developers borrowed from several banks – domestic, British and European – which will create an uneven playing field when removing toxic loans across the property sector.

While their numbers may be small, the borrowings of the biggest developers are not and fixing the banks following their borrowing frenzy will be complicated.

Decontaminating the banks of toxic loans could entail ugly scenarios that the banks and Government have not yet accepted, at least publicly, as the emerging reality.