A Canadian bank has held preliminary talks on buying a stake Allied Irish Banks, Ireland's second biggest bank, after it has been cleansed of risky loans, two sources familiar with the matter said.

One of the Reuters sources said on Friday that Canada's biggest bank, Royal Bank of Canada (RBC), had made the approach but the other source could not confirm which bank it was.

Allied Irish Banks declined to comment. The government, which has an indirect 25 percent stake in Allied via preference shares and which according to a report in Friday's Irish Times newspaper was also approached, declined to comment as well.

RBC officials in London did not return calls seeking comment.

The Irish Times said that RBC was known to have examined the Irish banking system recently but that any interest it might have in Allied Irish could not be verified.

Canadian banks have survived the global crisis so far in a relatively strong position while the former Celtic Tiger, now the worst performing euro zone economy, has seen banking scandals and 10 billion euros of state investment in the sector.

The Irish Times said the potential suitor was believed to be one of top five lenders, which after RBC are Toronto-Dominion Bank, Bank of Montreal, Bank of Nova Scotia and Canadian Imperial Bank of Commerce.

The sources said the Canadian bank would only invest after Allied's risky property development loans were moved to the National Asset Management Agency (NAMA), Ireland's new bad bank project, which still faces several political and legal hurdles.

Initial contact did take place, one source told Reuters on the condition of anonymity. It's at very, very early stages, it's not something that's going to happen in the short term.

Shares in Allied Irish traded 7.1 percent higher at 2.25 euros by 1200 GMT, up from the outset of trading after the Irish Times story. They are up from a low of 0.27 euros before the state bailout this year but was still way below the 24 euros it fetched two years ago before Ireland fell into recession.

Bank of Ireland, the country's top bank, rose 1.4 percent to 2.09 euros after rising as high as 2.27 euros.

Analysts said foreign suitors could be betting on an eventual recovery in the Irish economy from 2010 or 2011 which would greatly boost profitability at Allied Irish Banks and Bank of Ireland.

I wouldn't be surprised if we heard other instances over the next few months of foreign banks expressing an interest in Irish banks as loans go into NAMA, Goodbody analyst Anna Lalor said.

Davy analyst Emer Lang agreed further suitors could be found, with the banks' valuation dependent on the discount on loans transferred to NAMA, which will have a book value of up to 90 billion euros.

The recent publication of the draft NAMA legislation and the relative 'cheapness' of the Irish banks ... has put the Irish banks firmly back on investors' radar screens, Lang said.

(Reporting by Andras Gergely; additional reporting by Steve Slater in London; editing by Hans Peters and Karen Foster)