UPDATE 1-Ireland wants bailout fund to stump up for bank stakes

* Irish govt doesn’t want “hedge fund” prices for banks

* Irish debt agency says band deal would enhance market return

* Eyes 3-5 bln euros from new instruments aimed at domestic market (Adds detail, quotes)

DUBLIN, July 19 (Reuters) - Ireland’s finance minister said on Thursday that if Europe’s new rescue fund takes over the government’s stakes in its banks, it would need to do so at prices significantly above their current low valuations.

Euro zone leaders agreed last month to allow its rescue funds to recapitalise banks, and Ireland wants to benefit from this retrospectively as part of ongoing talks to improve the terms of its bank bailout.

Ireland is hoping to reduce its debt burden, which is set to peak at just under 120 percent of gross domestic product (GDP) and which Michael Noonan said on Thursday could prevent it returning to the bond markets at reasonable rates.

“We wouldn’t think we were being assisted or treated fairly if we were only offered the terms we could get from a willing hedge fund who wanted to purchase the stake the Irish government has in the banks,” Noonan told a news conference.

“The valuation will be an issue for negotiation but before we could agree, they would need to be significantly in advance of those figures,” Noonan added, referring to figures showing that investments by the country’s National Pension Reserve Fund (NPRF) in its top two banks were now worth 8.1 billion euros.

The NPRF invested just over 20 billion euros at a loss into Bank of Ireland and Allied Irish Banks, and the government directly invested a further 4.8 billion euros into AIB and 2.7 billion into permanent tsb.

Noonan, who has been campaigning for a year to soften the terms of the country’s bank bailout, wants to see some form of long-term economic value recognised if it sells its stakes in the country’s three remaining viable domestic banks.

Talks on improving the bank rescue are due to be completed by October, and the head of Ireland’s debt agency said a significant improvement to the terms of the rescue would greatly enhance the country’s prospects of making its planned return to long-term bond markets later this year or early next.

The International Monetary Fund (IMF), one of Ireland’s troika of lenders, also said this week that the talks were a key step towards Ireland getting out of its continued dependence on official funding.

National Treasury Management Agency (NTMA) chief executive John Corrigan said resolving the wider euro zone sovereign debt and banking issues were also critical to any full market return.

After returning to short-term bond markets earlier this month for the first time since its EU/IMF bailout in November 2010, Corrigan said the agency had yet to decide whether to run another treasury bill auction next month as part of three or four more planned this year.

The NTMA also confirmed plans to diversify its sources of funding later this year with its first sovereign issuance of annuity bonds to Irish-based pension funds and inflation-linked bonds also aimed at domestic investors.

Corrigan said it was not inconceivable that it could raise 3 to 5 billion euros over the next 18 months from the two new instruments.

“International investors don’t owe us a living, they don’t have to buy our paper, and if the local investors don’t have the confidence to invest in the market and aren’t seen to have that confidence, it’s going to be very difficult to get international investors back,” he said. (Additional reporting by Lorraine Turner; Editing by Hugh Lawson)