The surprise move comes just weeks after NatWest said it was winding down its underperforming Ulster Bank business in the Irish Republic, a move that had already left the country with just four retail banks.

Irish Finance Minister Paschal Donohoe said in a statement that KBC's decision to seek the sale - involving most of KBC's performing loans and deposits - was regrettable but hoped the negotiations with Bank of Ireland would conclude quickly.

"It is the case that the competitive dynamic has changed, I couldn't pretend otherwise to your listeners this morning," Donohoe told national broadcaster RTE, adding that additional competition would come from non-bank lenders.

The transaction remains subject to due diligence, further negotiation and agreement of final terms, the two banks said. KBC Bank Ireland CEO Peter Roebben said the talks were at a "very, very early stage".

Bank of Ireland's shares were 6.6% higher at 0740 GMT while KBC was up 1.8%. Bank of Ireland should be able to fund the transaction with its own resources, Goodbody Stockbrokers analyst Eamonn Hughes said in a note, describing it "a potentially very accretive deal for the bank."

KBC had 10 billion euros ($12 billion) worth of Irish loans, 5 billion in deposits and a 12.6% share of the mortgage market at the end of last year. It gave no specific reasons for wanting to exit the Irish market but in a statement cited "the challenging operational context for European banks".

Exits by KBC and NatWest look set to further strengthen Bank of Ireland and main rival Allied Irish Banks' grip on their home market. AIB entered an agreement with NatWest to buy around 4 billion euros of corporate and commercial loans.

The withdrawal of a string of foreign banks a decade ago following Ireland's banking crash made the two banks the dominant players in a market former European Central Bank President Mario Draghi once described as a "quasi-monopoly".

KBC is also reviewing its options to divest its non-performing mortgage loan portfolio, which is not part of the agreement with Bank of Ireland, it said.

Ireland's central bank said in a statement it understood there will be concerns that the KBC transaction, if it goes ahead, will reduce competition and choice in the market.

"Competitive pressures can clearly have an effect on the functioning of the financial system," Ed Sibley, deputy central bank governor with responsibility for prudential regulation, said.

($1 = 0.8345 euros)

(Reporting by Padraic HalpinEditing by Jason Neely and David Holmes)

By Padraic Halpin