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UPDATE 2-Regulator eases UK bank rules to support lending

* FSA relaxes capital, liquidity rules to prevent economychoking

* 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 regulatorsaid on Wednesday it has relaxed capital and liquidity rules onbanks in an effort to stimulate lending and boost therecession-hit economy, lifting bank shares.

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

But industry sources and analysts said there were mixedmessages coming from regulators on capital rules, includingseveral recent suggestions that more capital was needed.

FPC member Robert Jenkins, one of the committee'shardliners, said on Wednesday banks may need more capitalbecause a rule to curb balance sheets is too generous and urgedbank shareholders to support bolstering balance sheets.

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

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

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

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

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

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

Confirmation that the shift in policy was now beingimplemented lifted bank shares, as British regulators have beenamong the strictest in implementing new global regulations.

"If they get a bit of leeway from the regulator, that isbreathing space for these banks which, in the short term, isgood 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 fallin the European bank index .

MIXED MESSAGES

Minutes of the MPC's September meeting showed it wantedbanks to tap outside investors for capital and said policymakershad a range of views about the existence and strength of anytrade-off between tighter regulation and greater lending.

It also said it would consider giving banks more preciseindividual guidance on how much capital to raise at its nextmeeting.

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

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

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

The shift to a fixed amount of capital from a capital ratiochimes with a move by the European Union's banking regulatorlast week.

The European Banking Authority said EU banks, which had beenrequired to hold capital of 9 percent of their risk-weightedassets, will in future be told to hold a set amount, so they donot need to top up capital if they increase lending.

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

FLS, a scheme that offers banks cheap finance if theyincrease lending to households and businesses, opened at thestart of August but has yet to get credit flowing and prove itsworth.

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

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

Keywords: BRITAIN BANKS/FLS