Brussels' threat triggered a fall in Irish sovereign debt, stoking fears the ongoing financial crisis means more pain including the spectre of forced discounts for investors, despite an €85bn (£72.5bn) EU/IMF bailout.
"With regard to Allied Irish Banks, the final decision will depend on the Commission being satisfied (it) will be commercially viable in the long term without further injections of taxpayers' money (and)...that there is a significant contribution by the bank's shareholders and subordinated debtholders," the Commission said in a statement.
Years of reckless lending brought Ireland's banks to the brink of collapse, forcing the government to seek emergency aid and requiring Irish people to endure years of cutbacks and tax increases in return.
"What we've had in the last few weeks is evidence that there will be a forced restructuring of the subordinated debt – the fear is, of course, someone has to pay," said Steven Major, global head of fixed income research at HSBC in London.
With a parliamentary election looming early next year, Prime Minister Brian Cowen wants junior bondholders in the banks to shoulder some of the cost of propping up the industry and ease the burden on angry voters.
But legislation allowing the government to impose losses on subordinated bondholders could face a possible constitutional veto if the country's president decides to refer the law to the Supreme Court.
The controversial bill gives the state wide-ranging powers to restructure the banking industry. But its scope has raised objections from the European Central Bank and opposition politicians, who warn it will make Finance Minister Brian Lenihan a "one-man legislature".
"It looks likely that President McAleese will send the bill to the Supreme Court," said Fergal O'Leary, head of capital markets at Glas Securities. "I would say there is a market expectation the Supreme Court might very well turn it down."
If McAleese decides to refer the legislation to the Supreme Court it could delay government plans for junior creditors in Irish banks to swallow losses as agreed under the bailout.
The premium investors demand to hold Irish debt over benchmark German bunds widened 32 basis points to 622 basis points today.
Ireland's bailout will cover its sovereign funding requirements for the next three years and provides €35bn in additional capital for the banking sector.