UPDATE 2-Ireland eyes "novel" promissory note solution -c.bank
* Irish c.bank says deal with ECB not yet "done and dusted"
* Solution will be in the interests of eurosystem as a whole
* Irish PM says confident deal will be reached by March
DUBLIN, Jan 16 (Reuters) - Ireland is working on a "novel" solution to reach a deal with the European Central Bank on rescheduling part of its bank debt, which will not take policymakers too far out of their comfort zone, its central bank governor said.
Dublin has been negotiating with the ECB for over a year to ease the tough repayment terms on promissory notes, or IOUs, that it pumped mainly into the failed Anglo Irish Bank, and wants a deal agreed before the next payment falls due in March.
Ireland's Prime Minister said on Wednesday that he was confident a deal on the 31 billion euros ($41 billion) of debt would be struck by then, meaning Dublin could avoid large interest payments that come into effect from this year.
But central bank chief Patrick Honohan said later that although considerable goodwill existed, a solution was not yet "done and dusted".
"Taking into account both the statutory position and wider policy stance of the ECB, an initiative of this type will be novel and as such challenging," Honohan, who represents Ireland on the ECB's board, told a parliamentary committee.
"We have been working carefully to build understanding and confidence around a set of proposed transactions designed to deliver for Ireland, while not taking other decision-makers too far out of their comfort zone.
"The ECB is an organisation that seeks to proceed as far as possible by consensus, and it is not surprising that this work has been taking quite a while," he added. "In fact, what we have designed is, I believe, largely in the interests of the eurosystem (of euro zone central banks) as a whole."
Honohan did not give any details of the proposal.
Bailed-out Ireland is seeking to extend the duration of the notes, annual repayments on which total 3.1 billion euros. Avoiding a hefty interest charge this year would help reduce Ireland's budget deficit by more than a percentage point, according to finance department estimates.
The International Monetary Fund, which with the European Union came to the country's aid in November 2010, has said a deal is essential to ensure Ireland's smooth return to bond markets when its bailout ends this year.
"PUT TO BED"
Anglo's collapse, seen as emblematic of the casino-style lending practices that obliterated the local banking sector and pushed Ireland into its bailout, is expected to cost the equivalent of close to one-fifth of Ireland's annual output.
Honohan said exploiting the failed lender's "differences" would allow Dublin to design a measure that would not leak into other situations that were not comparable, thus soothing some worries among policymakers.
Ireland avoided last year's 3.1 billion euro promissory note cash payment, earmarked to repay emergency funding from the country's central bank, by settling the bill with a 13-year bond. Honohan said on Wednesday that Dublin was now looking at something long term that would "put the issue to bed".
"This design will definitely be very advantageous to Ireland, it will definitely allow a slower, better path to the debt going forward," the central bank governor said.
"Of course any transaction that involves lengthening of maturities, it can end up adding up lots more years of interest. But if those interest rates are sufficiently low then that is also advantageous, so don't worry on that count."
While the ECB talks were the central bank's primary international priority, Honohan said resolving the problem of mortgage arrears was "absolutely" the most important domestic policy issue. More than one in six Irish home loans are not being fully repaid.
He said there were risks to both customers and the state's finances over how the country's mostly state-owned banks ultimately deal with the problem but that the consequences of not delivering would mean they would require more capital.
Honohan added that while the condition of the economy and its banks still left much to be desired, and that unemployment was "shockingly high" at close to 15 percent, things were moving in the right direction, leaving the government well placed to exit the bailout on schedule.
"The government's efforts to exit the (bailout) programme are credible and we're backing them," he said.