Institutional investors want the government to convert some of its preference shares in AIB and Bank of Ireland to ordinary shares before they decide whether to participate in rights issues by the big two banks.

According to institutional sources, the big traditional bank shareholders want to see the government invest in the major banks first to give a sense of "direction" to the market before committing any fresh funds of their own.

They fear that a new equity issue may not be fully subscribed without government involvement or that they could be diluted by a subsequent conversion of preference shares, the sources said.

"A government conversion of preferences shares to ordinary shares first will do two things ? it will provide a reference price and show someone has done their due diligence," said a Dublin stockbroking source. "The government would also have to follow its cash in any subsequent rights issue, whereas a conversion of preference shares later would dilute shareholders."

The development marks a change in attitude for the institutions, which were poised to buy new equity in the Irish banks as recently as September, but lost interest as the Nama debate in the Dáil dragged into November and share prices fell to six-month lows. It also presents a dilemma for finance minister Brian Lenihan, who has expressed a definite preference for seeing private money commit to the banks before the taxpayer is again called upon to support them.

Last year the state put €7bn into AIB and Bank of Ireland in the form of preference shares. But analysts expect the banks to need anywhere from €7bn-€12bn of new core capital to cover writedowns associated with Nama as well as ongoing losses on loans. This is expected to come from asset disposals, debt for equity swaps, new equity and further state support.