UPDATE 2-Australia bows to years of pressure, announces bank inquiry

(Recasts, adds prime minister comment)

SYDNEY, Nov 30 (Reuters) - The Australian government said on Thursday it will hold a wide-ranging inquiry into the country's banking sector, reversing its long-held opposition to the potentially embarrassing measure as political pressure mounts.

Prime Minister Malcolm Turnbull said he would hold a royal commission, the country's most powerful kind of federal inquiry, into the scandal-plagued sector after a growing chorus of lawmakers in his conservative coalition vowed to support the move.

"Uncertainty ... over the potential for such an inquiry is starting to undermine confidence in our financial system and, as a result, the national economy," Turnbull told reporters.

"This is essentially a regrettable but necessary action. The political environment has created a sense of inevitability."

Australia's big banks have come under fire in recent years over a string of scandals including providing misleading financial advice, using outdated medical definitions to avoid life insurance payouts, rate rigging and failing to follow anti-money laundering protocols.

But the government had until now resisted building political pressure to call for a royal commission, which has wide ranging powers including the power to compel witnesses and recommend criminal charges.

Earlier on Thursday, the country's major banks took the highly unusual step of calling for an inquiry into the financial system.

The call was made in a joint letter sent by the heads of Westpac Banking Corp, Commonwealth Bank of Australia , National Australia Bank Ltd and Australia and New Zealand Banking Group Ltd to Treasurer Scott Morrison.

"We now ask you and your government to act to ensure a properly constituted inquiry into the financial services sector is established to put an end to the uncertainty and restore trust, respect and confidence," the letter read.

"It is now in the national interest for the political uncertainty to end. It is hurting confidence in our financial services system," the banks said.

Prime Minister Turnbull said the royal commission must report back to the government by February 2019.

Turnbull made the announcement before the start of share trading on Thursday.

(Additional reporting by Wayne Cole and Tom Westbrook; Editing by Leslie Adler and Lisa Shumaker)