By Dean Yates

EAST OF BAQUBA, Iraq, Oct 7 (Reuters) - U.S. and Iraqi security forces have made "substantial gains" against al Qaeda in Iraq but must keep up the pressure, especially in drying up the network's sources of cash, the U.S. commander in Iraq said.

General David Petraeus also defended an expanding policy that has seen tribes and neighbourhood groups help secure their communities, insisting the U.S. military was not trying to create more militias in Iraq.

In parts of Iraq, most notably western Anbar province, local Sunni Arab tribesmen have joined with Iraqi and U.S. security forces to fight al Qaeda militants.

"The actions against al Qaeda are encouraging. There have been substantial gains against al Qaeda," Petraeus told a small group of reporters on Saturday at a U.S. military base in Diyala province, where al Qaeda has been blamed for many attacks.

"Al Qaeda remains the wolf closest to the sled, the enemy that is always bent on re-igniting sectarian violence, causing the most horrific casualties. ... If you think we have our teeth into them, then we've got to keep them into them," he said.

The U.S. military blames al Qaeda in Iraq for most mass- casualty attacks. The group also often claims responsibility for killing Iraqi government officials and tribal leaders.

Al Qaeda in Iraq is largely a homegrown organisation that the U.S. military says has foreign leadership.

Petraeus said that besides combat against al Qaeda, an important element was to stifle the group's financial resources.

He pointed to the northern city of Mosul, where he said al Qaeda had been getting cash from businesses in cement, banking and real estate until security forces broke up the network.

"They were into everything and so what that enables them to do is to hire unemployed people. ... That's what so pernicious about them," Petraeus said.

NEIGHBOURHOOD SECURITY

Majority Shi'ites in Iraq have criticised the policy of involving tribes and local groups of men in providing security, saying U.S. forces were creating more militias.

The ruling Shi'ite Alliance of Prime Minister Nuri al-Maliki last week said many of the new fighters were stirring up trouble around Baghdad under the pretext of combating al Qaeda.

Petraeus said the military was not creating more militias nor arming tribes.

"What we are trying to do is take advantage of situations in which locals in some cases for the first time and perhaps ever since liberation ... are volunteering to serve in the Iraqi police," Petraeus said.

"They are seen as a force that can become part of legitimate Iraqi security forces. ... The idea is not for them to remain on our payroll indefinitely."

One of the architects in getting Sunni Arab men in Anbar to join up was tribal leader Sheikh Abdul Sattar Abu Risha, who headed the Anbar Salvation Council until he was killed last month in a bombing claimed by al Qaeda.

Abu Risha was replaced as head of the council by his older brother, Ahmed, who Petraeus described as "brilliant".

"He is a very, very impressive individual," Petraeus said of Ahmed Abu Risha, 42.

"He clearly has a vision. He has really thought through his relationship with the government of Iraq, with prime minister Maliki ... with Shia religious leaders and certainly Sunni religious leaders."

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