The taxpayer stands to lose nearly €400m on "in the money" warrants if AIB and Bank of Ireland manage to each redeem €1.5bn of the €7bn worth of preference shares the government used to recapitalise the two banks earlier this year.

The warrants, which allow the state to buy ordinary shares in the banks at an attractive price, were attached to the recapitalisation to sweeten the taxpayer benefit and are currently worth roughly €940m as the price of the shares has risen above the strike price, according to Davy Stockbrokers.

However, if both AIB and Bank of Ireland manage to raise enough core Tier 1 capital to redeem the maximum amount of the government's 25% stake before the December deadline, the value of the warrants would drop to about €550m. The deal between the government and the banks allowed for AIB and Bank of Ireland to buy back 40% of the government preference shares, which would reduce the taxpayer holding in the institutions from 25% to 15%.

In addition to reducing the total 8% coupon payments the banks pay for the investment, such a buyback would also cut the warrant pay-off by 40%.

This option was included in the original deal as an incentive to the banks to seek private sources of capital.

It was also conceived at a time when the prospects of a recovery in the banks' share prices were far from certain. Now that the stocks have recovered somewhat, largely because of state interventions such as the recapitalisation and Nama, the greater bank independence has become an opportunity cost for the taxpayer.

At the moment, however, the notion of either bank being in a position to raise the capital necessary to redeem €1.5bn in preference shares is highly theoretical.

Bank of Ireland, under new chief executive Richie Boucher, is understood to be considering a rights issue for November precisely to effect such a redemption and is planning an investor roadshow in a couple of months to drum up interest, but the outcome of such moves is far from certain.

Meanwhile, AIB is still struggling with rising impairments. The government has estimated the bank needs to raise €1.5bn in fresh capital just to absorb the associated losses, so a rights issue by the end of the year seems remote.

If Bank of Ireland manages to raise the money to buy out the government, the taxpayer will take a €200m hit on the warrants.