AIB shares, which fell as low as €11.35 after the revelations of Allfirst foreign exchange losses first broke two weeks ago, traded strongly for the second successive day on the Dublin and London markets - fuelled by speculation that Royal Bank of Scotland (RBS) is putting together a merger/takeover proposal for the two banks.

At yesterday's closing price, AIB is valued at just under €12 billion (£9.45 billion) while RBS - one of the biggest banks in Europe since it took over Natwest - is worth around €80 billion at yesterday's closing price on the London market. RBS has expanded aggressively in recent years under the direction of chief executive Mr Fred Goodwin, and many analysts believe that while there might be regulatory issues to be overcome with AIB, the Scottish bank is more likely to be attracted to a deal with AIB rather than a bid for a mainland European bank.

But sources close to AIB said that it had received no direct or indirect approaches from RBS. Market sources in Dublin were sceptical also about the likelihood of such a development and even more sceptical about the suggested €14.50 valuation on AIB shares. However, the rumours were sufficient to send AIB shares up €1 in early trading to €13.40 - not far short of their level before the $691 million losses at US subsidiary Allfirst were first disclosed. In later trading, however, the shares weakened and closed up 60 cents on €13.

Turnover between Dublin and London was a modest 4.4 million shares, indicating no evidence of any stake-building by RBS or any other potential bidder. RBS itself was in strong demand on the back of the AIB bid rumours and jumped 59p to £17.43 sterling

Dealers said late last week, there was some sizeable buying of AIB by two British institutional investors, but that seemed to be more based on AIB's current discount to the European banking sector rather than on any real expectation of a takeover bid. "All of these rumours are coming out of London but it's hard to see RBS or anybody else making any move on AIB before the Allfirst situation is clarified," said one Dublin market source. While both AIB and RBS - in a closed period ahead of its full-year results on Thursday - have refused to comment on the latest weekend reports which suggested that RBS's financial advisers UBS Warburg and Merrill Lynch have been preparing the ground for a major corporate move involving the bank and AIB. The reports suggested that a merger proposal would value AIB at €14.50 a share or a total of €12.9 billion, but Dublin market sources said this sort of pric would be far too low for the AIB board to even consider.

In a research note yesterday, Davy analyst Mr Scott Rankin warned that while there was logic in a link-up from RBS's perspective, a problem would arise in the combined entity's market share in the SME market - particularly current accounts - on both sides of the border. Davy estimates that AIB and the RBS-owned Ulster Bank has a combined market share of close on 50 per cent.

"This could prove a stumbling block. Branch closures might not suffice and it might even take a disposal of Ulster Bank to satisfy competition concerns," said the Davy analyst who estimates a 20 per cent branch overlap North and South of the Border. The Davy analyst suggests the in the event of a bid from RBS, Irish institutions might look for a sizeable cash element, and that might pose a problem for RBS in generating a return in excess of the cost of capital