Remember that discredited term “too big to fail”? It has returned with a vengeance. The €85bn bail-out of Ireland being finalised in Brussels on Sunday is a bank rescue job. The Irish have been hurt not by the excessive borrowing, tax evasion or false national statistics that troubled the Greeks. What brought Ireland down were its banks; they have sunk the sovereign.

Irish bank assets became grotesquely out of line with the nation’s economy during the property bubble. It was in the belief that they were too big to fail that the government, in September 2008, offered a blanket guarantee to bank creditors. Some form of guarantee was essential; it is now clear that the one offered was excessively generous. Contingent liabilities have become actual liabilities. The country cannot afford to absorb these losses. Some €35bn of the bail-out funding is likely to go to recapitalise and provide liquidity support for the banking system, on top of the taxpayer-funded financing it has already received.

What has happened at Irish banks will be viewed with horror across Europe. After all, they passed this summer’s European banking stress tests. The credibility of that exercise is now in question, just as it becomes more difficult, in this protracted eurozone crisis, to distinguish between sovereign borrowers and their banks.

The wider fear is that Ireland’s bail-out will become a template for Europe’s banks. Barclays Capital estimates Irish senior bank debt is 38 per cent of gross domestic product; that is less than in Belgium, Spain, the UK and Holland. Spanish banks face a hefty refinancing schedule up to April; this could put pressure on the government’s ability to do its own financing. Ireland’s bail-out is essential. It is also deeply troubling. Ireland is not the only European country that let its banks become too big to rescue.

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