* Regulatory body wants banks to keep more funds on hand
* Definition of acceptable capital would be tightened
* Investors fear new rules could see banks scramble for cash
* Rules to take effect by end-2012, but may be delayed
* European bank stocks slide in response
(recasts with details of capital rules, analysis)
ZURICH/ BRUSSELS, Dec 17 (Reuters) - Banks face having to set aside more funds or raise fresh capital from investors in as little as three years, according to proposals by a global regulatory body that could change the way bankers do business.
Seeking to prevent a repeat of this year's financial crisis, the Basel Committee of central bankers and financial supervisors on Thursday demanded higher requirements for the capital which banks maintain to shield depositors and shareholders from loss. Also, the definition of acceptable capital would be narrowed.
Although the recommendations are not binding, they herald a tougher regime for banks; regions such as the European Union will use them as a reference, and higher capital requirements may end up slowing down lending or investment banking business. On Thursday, the EU said it was studying the Basel report.
"There were a lot of areas in finance which were hardly regulated, such as investment banking," said Rym Ayadi, industry expert with the Centre for European Policy Studies.
"If these new rules are implemented...this would be the end of that. It could change the way banks work, making them more focused on financing the real economy."
European bank shares fell on Thursday partly in response to the Basel Committee's report, as investors fretted that tighter capital requirements could force banks to issue more shares to raise funds.
The DJ Stoxx index of the region's bank stocks .SX7P slid 2.7 percent, while Britain's Lloyds (LLOY.L), highlighted by Credit Suisse analysts as particularly vulnerable to tougher regulation, tumbled 8.1 percent. [ID:nLDE5BG209]
(for a factbox on key elements of the Basel report, click [ID:nLDE5BG15N])
The Basel Committee did not come up with specific numbers for higher capital requirements on Thursday; they will be worked out in consultation with national regulators next year.
The committee wants the changes to take effect by the end of 2012, but they may be postponed if the global economy is still struggling at the time, the committee's secretary general Stefan Walter told Reuters.
"We are going to do an impact assessment and finalise the proposals by the end of next year. By then, we will also make a decision about the appropriate implementation time line. That depends on the economic development," he said.
Global regulatory sources told Reuters on Wednesday that the new requirements would be implemented gradually and flexibly, giving banks enough time to adjust. Regulatory changes introduced by the committee in 2004 came with 10-year transition periods for some requirements. [ID:nTOE5BF01O]
However, the latest measures could be revolutionary for some banks; among other things, the committee wants the first-ever global introduction of a leverage ratio, which would force each bank to set aside a fixed amount of capital based on the size of its balance sheet.
The committee also aims to restrict the types of capital on which a bank can rely to prove its financial stability. In future, lenders should primarily use retained profits and shareholder equity, the most liquid form of assets on a bank's balance sheet, the committee said.
This is in stark contrast with the past, when banks used a wide range of assets, many of which crumbled during the financial crisis. Many European banks use so-called hybrid capital such as a convertible bonds, for example.
"At first read, it looks pretty punitive," the Credit Suisse analysts said of the committee's report. "Overall, we believe this is negative for the European banks sector."
The new rules could reduce banks' freedom to pay dividends, conduct share buy-backs and pay bonuses to staff, by imposing "capital distribution constraints" on them if their capital fell into a certain range.
The committee is eager to have banks build up capital buffers in good times, reducing their need to raise capital during economic downturns, when asset sales could weaken financial markets further.
It also aims to restrict risk-weighting, which has allowed banks to brand some loans as low-risk and thereby reduce the capital they hold to cover non-payment.
Another proposed change is the introduction of a minimum liquidity standard for internationally active banks, based on how much cash they would need to withstand a financial shock.
Johannes Wassenberg, analyst at Moody's rating agency, said that while the rules might hurt bank stocks, they could ultimately boost banks' credit ratings by making them safer, if banks did not find ways to move business outside the scope of the rules.
He said the leverage ratio might not be a major burden on most banks, since they had already reduced their leverage from between 30 and 40 times equity before the crisis to 25-30 times, an area which would probably satisfy regulators.
"A lot of banks have already delevered quite radically since the fourth quarter of 2008...They already have adjusted."