Even after the downgrade from S&P, Irish debt is still rated A. That allows Irish banks to put up collateral with a minimum haircut (discount). But if Irish debt was downgraded to BBB, or if the Irish government stopped guaranteeing bank debt, the haircut would rise, from a 3-6% range, to 10-30% or more. That would require the banks to put up more cash.
What if they couldn't afford it? Then the ECB would be left with the collateral. Mr Nangle suggests this collateral might only be worth 40 cents on the euro in such a situation, for a loss of €78 billion. He points out that
Well, €78 billion also happens to be the amount of capital for the ECB. The ECB would be revealed as bust and in need for recapitalisation.