AIB and Bank of Ireland, the two remaining banks listed on the Irish stock market, need the support of investors more than ever as they both embark on programmes to rebuild their balance sheets after a period of major losses. But their efforts to raise vital capital in the coming months could be complicated by the unusually high proportion of small retail investors in their shareholder base.

Stockbrokers have noticed that significant differences of opinion about how the banks should raise new money are emerging between traditional, large institutional investors, such as asset management companies and pension funds, and smaller, individual investors, who now make up about half the stockholders in both of the big two.

The divergence raises questions about how much power small investors now wield and whether banks need to spend more time and effort educating retail investors to demystify complex transactions such as rights issues or business disposals.

"The picture from the banks is more difficult for retail investors to understand," said Kevin McConnell, head of research at Bloxham Stockbrokers. "Institutions would have a firmer grasp on the issues involved. There needs to be a clearly articulated explanation of exactly what's going on, because the retail investors are now very important."

A survey of investors conducted by Bloxham last month found a 10 percentage-point decline in support among small shareholders for a rights issue in either AIB or Bank of Ireland compared to July 2009, while support from institutional investors actually increased. McConnell put this down to the strong recovery in bank shares last summer and the relatively poor performance since December, which affected retail sentiment.

Retail investors have a much more negative view of a government shareholding than institutional investors. Two-thirds of small shareholders said a controlling stake by the state would make them reluctant to invest more in the bank. Only half of institutions felt the same way. A majority of institutional shareholders also viewed the conversion of the government's 25% preference shareholding in the banks as positive. Retail investor support for conversion, on the other hand, plummeted after the government took a 15.7% stake in Bank of Ireland last month in lieu of coupon payments on the preference shares. Bloxham put this down to a realisation among individual investors of the real consequences of conversion – dilution.

"Intuitively it seems negative, but theoretically it was a positive development because it effectively raised €250m in capital," said McConnell. "Sentiment has a much bigger bearing on retail investors than on long-term institutional shareholders."

The banks are reluctant to talk about this for two reasons. First, neither AIB nor Bank of Ireland has formally announced a rights issue or other capital-raising effort, such as a major asset sale, which would require shareholder approval. Second, speculation on the voting inclinations of shareholder blocs could be price-sensitive and, therefore, is restricted.

Yet bank sources have told the Sunday Tribune that having such large numbers of retail investors on the share register makes the outcome of any potential rights issue more unpredictable, even though institutional and individual stockholders officially have access to the same information at the same time. Not all investors feel that is true, though.

"I don't think retail investors are being kept in the loop," said one small shareholder who built stakes in both Bank of Ireland and AIB last spring when share prices hit all-time lows. "We are not being told 'we expect a return of dividend by X' or any guidance on how the banks will genuinely turn around. They aren't taking decisions that favour their investors even though that is their fiduciary responsibility. Currently they are acting in favour of their funding source, the state, rather than those they are legally bound to represent and protect."

The banks will have to deal with this sort of opinion when they ultimately go to the markets seeking fresh funds to plug their multibillion-euro capital holes. Having to satisfy the concerns of a big, diverse group of investors could prove difficult, as Lloyds found last November when it had to persuade its 2.8 million shareholders to support a £13.5bn fundraising.

"You want everything to go smoothly when you're doing a rights issue," said one senior analyst at a Dublin stockbroker. "It's much easier to deal with 100 institutions than it is to deal with 100,000 individuals."

Another issue for retail investors is the cost of a rights issue. It's one thing for a large institution with a huge pool of investor funds to come up with the money for a cash call, but an individual who bought 100,000 shares in Bank of Ireland when the stock was trading at €0.12 would have to front a multiple of the €12,000 he paid for them to avoid being diluted. By contrast, the average private shareholder in Lloyds needed to commit only another £367 to take up the rights. The credibility threshold for the Irish banks, which need to raise two or more times their market value, is potentially much higher as a result.

"For me to dive in I'd need credible evidence that the banks are serious. By that I mean firing staff, increasing lending rates across their product suite and dropping deposit rates," said one bank shareholder who is also a financial professional. "Failing that, you are buying a franchise name with brand value and nothing under the hood."

Wooed by Lloyds

Lloyds, the part-nationalised bank that owns Bank of Scotland Ireland, sold 36.5 billion new shares last November to raise £13.5bn as part of a massive fundraising effort to keep the bank out of the British government's asset protection scheme.

The board succeeded by getting 95% of its 2.8 million shareholders – many of them small retail investors – to subscribe, leaving the underwriters with a tiny amount left over to mop up. The bank made a massive effort just to contact everyone and inform them of their rights. It also sweetened the deal by pricing the issue at the low end of the discount range, making it cheaper for investors to participate. Retail shareholders were also offered a free dealing service and the option of selling enough rights to fund the purchase of the rest, known in market parlance as "tail-swallowing". Irish brokers say similar moves will be necessary for AIB and Bank of Ireland.