Ireland’s banks are the root of its fiscal meltdown and with funding costs rising and additional capital calls looming they still risk pushing the European debt crisis into overdrive despite a rescue deal that Dublin agreed with the EU and the IMF last year.

Fellow bailout beneficiary Greece won a 1 percentage point cut from last weekend’s summit on the rate of interest it pays on its EU loans, meaning Kenny’s confidence that he can secure a similar deal at an EU summit on March 24-25 seems well placed.

Jean-Claude Juncker, who chairs meetings of euro zone finance ministers, indicated a similar cut was on the cards on the EU portion of Ireland’s 85 billion euros bailout, news agency Market News International reported.

But that alone is unlikely to be enough to win round markets.

“Ireland needs a mix of measures by the end of the month that make it clear to the market that it has sustainable debt levels,” said one source familiar with the negotiations between Ireland and its creditors — the EU, the IMF and the ECB.

“That’s not on the table at the moment.”

Driving Dublin’s determination for fresh concessions on the banks is an expectation that a new round of stress tests will reveal more holes in their balance sheets that the state will have to fill when they are published at the end of March.

Under the terms of the EU/IMF bailout, some 35 billion euros was earmarked for the banks, brought to the brink of collapse through reckless property loans.

Of this, up to 10 billon was meant to be injected ahead of the stress tests to ensure that Bank of Ireland, AIB and EBS Building Society were capitalized above a minimum Core Tier 1 requirement of 10.5 percent.

The remaining 25 billion euros was meant to be a contingency fund.

Kenny’s government, swept to power last month on a wave of anger over the country’s financial crisis, has delayed the capital injections until the results of the tests.

Although Ireland’s banks have offloaded most of their risky commercial property portfolios via a state-run “bad bank,” rising mortgage arrears and climbing funding costs are expected to show a deterioration in their balance sheets.

Estimates for how big a capital shortfall will be revealed range from 10 billion euros up to the full 35 billion euros. The chairman of nationalized lender Anglo Irish Bank Alan Dukes sent a chill through Dublin when he said last month a clean banking core would require 50 billion euros in new capital.

Ireland’s central bank, which is conducting the stress tests, dismissed Dukes’ predictions but there are concerns that tapping the 25 billion euros fund less than six months into the bailout would trigger more rating cuts, boosting funding costs.

“The problem with the contingency fund is that if you draw down any chunk of it then Ireland could suffer serious downgrades which would raise serious questions about Irish debt sustainability,” said the source familiar with negotiations.

The IMF has said if the full 35 billion euros is used Ireland’s debt ratio will peak at 125 percent of GDP in 2013.

S&P has warned it could strip Ireland of its last ‘A’ rating after the stress tests. Another spiral of downgrades would further raise the banks’ dependence on loans from the central bank and the ECB, which amounted to a jaw-dropping 187 billion euros last month.

Kenny signalled over the weekend that the results of the stress tests would help him get a cut of 100 basis points, the same reduction Greece got, on the average 5.8 percent interest rate charged by the EU on its 40 billion euros of loans.

Goodbody Stockbrokers have estimated that such a cut would save 675 million euros or 0.4 percent of GDP annually, helpful but not enough to make a big difference to debt sustainability.

In addition to a rate cut, Kenny’s Fine Gael party has suggested reducing the recapitalization cost either through Europe taking a stake in some of the Irish banks or through creation of an insurance fund to cover possible future losses.

Ireland also wants the ECB to give the country more time to shrink the sector so as to reduce its dependence on ECB funding, and fears any fire-sale of assets would blow bigger holes in banks’ balance sheets which the taxpayer would have to plug.

But concessions would set an expensive precedent should banking problems emerge in other euro zone states like Spain, which last week had its rating cut after Moody’s more than doubled its estimate on Spanish banks’ funding needs.

And Europe will want something in return from Ireland, namely an increase in Dublin’s low corporate tax rate, the bedrock of its industrial policy and a “no go” for Kenny.

Beyond the threat of a sovereign default, which no one wants to contemplate, the only other weapon Kenny has in his armory is a threat to impose losses on senior unsecured bonds in Irish banks not covered by a state guarantee, currently amounting to over 16 billion euros.

A cabinet minister said on Sunday that such “burden sharing” was still on the table despite ECB opposition.

“The only card Ireland has to play is for senior unsecured bondholders taking losses,” said Rory Murray of Glas Securities. .”..(But) any action against senior bondholders in Ireland would likely ripple through to other European peripherals.”

But even threatening something in the face of ECB opposition is risky, especially as the bank is keeping the Irish banks afloat.