THE STATE'S two largest banks, AIB and Bank of Ireland, had their debt rating outlooks downgraded to "negative" from "stable" by international rating agency, Standard Poor's, which cited a "challenging operating environment" for the two institutions.

The agency also lowered the long-term counterparty ratings on Anglo Irish Bank and Irish Life Permanent (ILP) by one notch to "A-" from "A", saying that this reflected the deteriorating economic environment and "more specifically the clear challenges facing these banks' respective business models in their current form".

"The challenging operating environment will lead to pressure spreading from Irish property development lending to most segments of AIB and Bank of Ireland's loan books," said the credit rating agency. SP said profitability would be "materially diminished" in the coming couple of years due to higher credit costs, though it considers AIB to be the slightly better placed of the two financial institutions due to its "greater financial flexibility".

"While banks participating in the guarantee scheme are subject to the same degree of oversight and direction by the regulator, we consider that - of the four independent rated banks - Anglo and ILP are facing the most acute pressures to reshape their businesses in the coming two years," the agency said.

It added: "We do not currently expect that the long-term rating on either institution will be lowered by more than one notch, and they may be affirmed."

The six Irish-owned financial institutions covered by the guarantee scheme have to submit revised business plans for the two-year period of the guarantee to the Financial Regulator this month.

The agency has raised the ratings on any debt issued by the four public banks maturing within the two-year life of the guarantee to the same level as the AAA-rating assigned to the Irish sovereign rating because of the institutions' cover under the terms of the guarantee scheme.