Unlike the US FDIC or the British Financial Services Compensation Scheme,  Ireland has had, until today, a deposit insurance scheme to protect only something like the first €20,000 deposited by individuals into banks.

Key to the new scheme developed by the Irish government is the exclusion of non-Irish national banks operating in the Republic of Ireland.  For example, although San Francisco based Bank of America operates in Ireland, they are not covered by the deposit insurance scheme.  Which means that while deposits held in a Dublin branch of the Bank of Ireland are covered, those in a Dublin branch of the Bank of America are not.

This creates a massive incentive for a bank run on the Irish subsidiaries of international banks, creating the possibility of more US and UK bank failures if a run occurs on their Irish operations.  As well, bank executives from Irish national banks apparently went on BBC Radio 4 joking that British citizens should deposit their money into Irish banks.  

Because, while this Irish deposit insurance apparently does not cover deposits held by Irish citizens in non-Irish banks in Ireland, it does apparently cover the deposits of non-Irish citizens held in Irish banks outside of Ireland. The British insurance scheme only covers the first £35,000 (roughly $70,000).  Which means that the Irish just created a huge incentive for all British citizens holding accounts in excess of that to transfer their funds to Irish banks.  That seems like a good way to start an economic war.

One possible exception to the "Irish only" rule may be Ulster Bank, a bank domiciled in Belfast but operating on an all Ireland basis.  Brian Lenihan, Irish Finance minister, explained why only Irish banks were being covered:

Mr Lenihan emphasised that the Government had responsibility for the six domestic financial institutions, but other financial institutions owned by companies outside the State were the responsibility of other sovereign states.

And as for the economic distortion that this promises?  

The guaranteed banks received inflows of deposits from the UK, with one Irish bank receiving a single corporate deposit of €500 million after the guarantee was announced.

This is direct assault by the Irish on the financial primacy of the City of London, and it's only a matter of time before the boys on Wall Street find their Irish roots.

The irony (one of the) of this situation is that this whole move may have been precipitated by a potential takeover for the Bank of Ireland by Spain based Santander bank.

Now though the bug has spread, and European nations are acting to make guarantees similar to that made in Ireland to prevent deposit outflows to Ireland.  There appear to be two schools of thinking on this.

1) Follow the Irish

If the French follow the Irish, as they are believed to be considering, bankers said it would inevitably force all governments across Europe to follow suit. Depositors would then have to decide which sovereign guarantee was safest. Credit default swaps, effectively the cost of insurance against going bust, on Ireland's government bonds almost doubled yesterday after the announcement, indicating the level of risk transfer.

That article also notes that the European regulators have opened an anti-competition case against the Irish.

2) Spain is acting to pressure unified European level action to harmonize deposit guarantees.

Spain today joined the call for an increase in the guarantee limit on bank deposits across Europe, piling further pressure on UK Prime Minister Gordon Brown to support an ambitious plan for a €300 billion (£237 billion) bailout fund to rescue crippled banks.

The Spanish Treasury indicated today that it would support an EU move to lift guaranteed savings, but would not act unilaterally and copy Ireland's move to only guarantee domestic banks.

Again, Spain's Santander was heavily involved in supporting UK banks during their problems, and this declaration from the Spanish government is being interpreted as Spanish pressure on the Brits to join a European bailout scheme.

It's going to matter a great deal which side wins, because if the Spanish win, then the potential for crossborder mayhem is minimal.  But if other European countries follow the Irish, there is going to be the potential that this could trigger multiple bank failures as money chases bank guarantees across national borders.  

And this danger includes US corporate deposits.  So we could see runs on any number of banks that either have exposure in Europe, or have corporate accounts that can be shifted abroad.