Allied Irish Banks' junior bondholders will have to take a big hit in a future restructuring, the European Commission warned on Tuesday as it rubber-stamped billions of euros in state aid for Irish banks.

Brussels' threat triggered a fall in Irish sovereign debt, stoking fears the continuing financial crisis means more pain, including the spectre of forced discounts for investors, despite an 85 billion euro ($112 billion) EU/IMF bailout.

With regard to Allied Irish Banks, the final decision will depend on the Commission being satisfied (it) will be commercially viable in the long term without further injections of taxpayers' money (and) ... that there is a significant contribution by the bank's shareholders and subordinated debtholders, the Commission said in a statement.

Years of reckless lending brought Ireland's banks to the brink of collapse, forcing the government to seek emergency aid and leaving the Irish people facing years of cutbacks and tax increases.

What we've had in the last few weeks is evidence that there will be a forced restructuring of the subordinated debt -- the fear is, of course, someone has to pay, said Steven Major, global head of fixed income research at HSBC in London.

With a parliamentary election looming early next year, Prime Minister Brian Cowen wants junior bondholders in the banks to shoulder some of the cost of propping up the industry and ease the burden on angry voters.

President Mary McAleese signed into law on Tuesday legislation that gives the finance minister sweeping powers to overhaul the sector, paving the way for plans for junior creditors to swallow losses as agreed under the bailout.

The president earlier convened a meeting of the Council of State to advise her on whether the law should be referred to the Supreme Court.

The scope of powers given to the state under the law has raised objections from the European Central Bank (ECB) and opposition politicians, who warned it would make Finance Minister Brian Lenihan a one-man legislature.

The premium investors demand to hold Irish debt over benchmark German bunds widened 32 basis points on Tuesday to 622 basis points.


Ireland's bailout will cover its sovereign funding requirements for the next three years and provides 35 billion euros in additional capital for the banking sector.

Europe will start raising cash for Ireland in January, starting with bonds issued by the European Financial Stability Mechanism.

Dublin has agreed to shrink and restructure its banks in return for the external assistance, and the European Commission said on Tuesday that nationalized lenders Anglo Irish and Irish Nationwide would have to be wound down.

Anglo Irish and Irish Nationwide will have to submit a wind-down plan to Brussels early next year. AIB, which will be effectively nationalized following capital injections by the state, will have to submit a restructuring plan.

Anglo Irish said on Tuesday that a group of subordinated creditors had agreed to take an 80 percent writedown on the value of their holding, successfully concluding the lender's controversial debt restructuring plan.

The central bank, meanwhile, fined Allied Irish Banks 2 million euros on Tuesday for overcharging customers, sending its clearest signal yet that the disastrous era of light tough regulation was over for Irish banks.

And Ireland's National Asset Management Agency (NAMA) will take legal action against property developers who have transferred assets to their spouses to prevent them being seized by the state-run bad bank.

(Additional reporting by Yara Bayoumy in Dublin and the Brussels bureau; Editing by David Cowell, Alexander Smith and John Wallace)