Allied Irish Banks (AIB) has won regulatory approval to pay €1.7 billion of government bailout funds, beginning the process of repaying the €21 billion it received during the financial crisis in 2008 and 2009.

Ireland pumped a total of €64bn into its banks during the crisis, which, at almost 40 per cent of annual economic output, was the most expensive rescue in the eurozone.

State-owned AIB's rescue was the biggest bailout given to any Irish bank still trading.

AIB has been in discussions with European regulators about reorganising its capital structure, including how much it can repay the government from the €3.5bn of preference shares it owns in the bank.

Taking account of income due from the bank and €1.6bn worth of state-owned contingent capital notes (CoCos) due to mature next July, Ireland will receive close to €4bn ahead of a potential initial public offering (IPO) next year, Finance Minister Michael Noonan said.

"The changes announced today lay the ground-work for the Irish taxpayer to ultimately recover the full value of their 20.8 billion euro investment in AIB," Mr Noonan said.

If re-elected early next year, the government plans to sell a 25 per cent stake in AIB on the stock market and follow the part return to private ownership this year of Ireland's other state-owned bank, the much smaller permanent tsb.

AIB's chief executive Bernard Byrne, appointed to the role following David Duffy's move to Clydesdale Bank, said last week that investors see the country's second largest lender by assets as a good play on an economy that is set to be the fastest growing in Europe for a second successive year.

"The approval of these capital actions represents another key milestone in the transformation of AIB and positions the group to repay capital to the state and return to private ownership over time," Mr Byrne said.

The remainder of the preference shares will convert to equity and the 99-per cent state-owned bank said it had agreed to issue at least €750 million of Lower Tier 2 (LT2) and €500 million euros of Additional Tier 1 bonds (AT1) to achieve a net increase in its capital levels.