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UPDATE 2-Regulator eases UK bank rules to support lending

* FSA relaxes capital, liquidity rules to prevent economy choking

* FPC member Jenkins says banks may need more capital * Industry says mixed messages on capital add to uncertainty * Lloyds shares up 4.5 pct, UK bank shares rise

(Adds BoE's Jenkins, reaction)

LONDON, Oct 10 (Reuters) - Britain's financial regulator said on Wednesday it has relaxed capital and liquidity rules on banks in an effort to stimulate lending and boost the recession-hit economy, lifting bank shares.

The Financial Services Authority said the policy shift was set out in the Bank of England's Financial Policy Committee in September, and banks were aware of the changes.

But industry sources and analysts said there were mixed messages coming from regulators on capital rules, including several recent suggestions that more capital was needed.

FPC member Robert Jenkins, one of the committee's hardliners, said on Wednesday banks may need more capital because a rule to curb balance sheets is too generous and urged bank shareholders to support bolstering balance sheets.

"The old financial structure has crumbled and a new edifice is rising. But its foundation is flawed, the walls are thin and the beams are brittle," Jenkins said.

"The good news: there is still time for you to weigh in and strengthen the structure. Begin with the foundation. The foundation is capital."

The FPC said in June that banks could tap their 500 billion pound cash pile to increase lending to companies and added last month that the capital buffers could also be eased.

The FSA said banks no longer need to have a 10 percent core capital ratio but can instead hold a fixed amount of capital. The aim is to get banks to strengthen their capital and also be able to dip into buffers at times of difficulty so they can keep lending.

Andrew Bailey, head of the FSA's prudential business unit, said last week banks can cut the amount of capital they hold to the minimum requirements, and trim their cash-like liquidity buffers to help increase lending.

The regulator will also not require banks to hold extra capital against new lending that qualifies for a "funding for lending" (FLS) scheme targeted at loans to corporate borrowers.

Confirmation that the shift in policy was now being implemented lifted bank shares, as British regulators have been among the strictest in implementing new global regulations.

"If they get a bit of leeway from the regulator, that is breathing space for these banks which, in the short term, is good for the shares. Longer term, I stay very cautious," Bernstein Research senior analyst Chirantan Barua said.

Lloyds shares were up 4.6 percent by 1510 GMT, Royal Bank of Scotland firmed 2.6 percent and Barclays

added 0.8 percent, all outperforming a 0.2 percent fall in the European bank index .

MIXED MESSAGES

Minutes of the MPC's September meeting showed it wanted banks to tap outside investors for capital and said policymakers had a range of views about the existence and strength of any trade-off between tighter regulation and greater lending.

It also said it would consider giving banks more precise individual guidance on how much capital to raise at its next meeting.

The FPC's Jenkins said a planned global leverage ratio or cap on bank balance sheet growth was a "hedge fund manager's dream", meaning it would give lenders too much leeway to take risks.

Banks may be tempted to be less strict on whom they lend to if capital rules are relaxed, said Enrique Schroth of the Cass Business School.

"Lending may increase, but at the expense of higher default probabilities, and more severe recessions in the future," Schroth said.

The shift to a fixed amount of capital from a capital ratio chimes with a move by the European Union's banking regulator last week.

The European Banking Authority said EU banks, which had been required to hold capital of 9 percent of their risk-weighted assets, will in future be told to hold a set amount, so they do not need to top up capital if they increase lending.

Policymakers have been attempting to stop tougher new regulations from choking off economic recovery.

FLS, a scheme that offers banks cheap finance if they increase lending to households and businesses, opened at the start of August but has yet to get credit flowing and prove its worth.

(Reporting by Stephen Mangan, Steve Slater, Huw Jones and Toni Vorobyova; Editing by Dan Lalor and David Cowell)

((stephen.mangan@thomsonreuters.com)(+44 20 7542 7931))

Keywords: BRITAIN BANKS/FLS