UPDATE 4-Santander to sell nearly $1 bln stake in Chile unit

* Spain's Santander seeking to boost core capital

* Santander Chile shares plunge after sale announcement

* Market seen struggling to absorb $1 bln share sale

* Shares' percentage drop biggest in almost decade

SANTIAGO, Nov 22 (Reuters) - Spanish bank Santander SAN.MC> will sell a 7.8 percent stake in Santander Chile , worth around $1 billion dollars, to boost core capital, the Chilean affiliate said, sending the local unit's shares plunging.

Spain's Santander aims to boost its core capital to 10 percent by June 30, Santander Chile said in a statement issued in New York overnight.

The euro zone debt crisis has make funding scarce and deterred banks from issuing bonds. Banking sources said European lenders were also moving to free up funds by retreating from the $65 billion Australian syndicated loan market.

Shares of Santander Chile closed 8.5 percent lower on Tuesday, their biggest daily percentage drop in nearly a decade, outpacing a 1.36 percent loss on the wider Chilean blue chip share index .

While global regulators are asking banks to hold a minimum of 7 percent capital from 2013, the European Banking Authority has insisted that European banks go a step further and bolster their core Tier 1 capital ratio to 9 percent by mid-2012.

European governments want to make sure that banks in their region can cope with another round of writedowns of European debt amid euro zone financial turbulence, since the institutions in Europe are by far the top creditors of euro governments.

Santander Chile Chief Executive Claudio Melandri said Spain's Santander was unlikely to sell further stakes in its Chilean unit.

"In the particular case of Santander Chile, we don't think there will be any more sales," Melandri told Chilean newspaper La Segunda, which is published in the afternoon.

"After this sale, the group will have around a two-thirds stake in Santander Chile, which is a minimum level for a controlling shareholder."

Given spreading debt woes in Europe, analysts say other banks could follow Santander's lead and sell stakes to raise capital.

"I think it's possible. Santander's transaction sets a precedent," said Elizabeth Palma, an analyst with the Tanner brokerage in Santiago.

"Assets (of European banks) in Latin America are pretty profitable. They could look at Chile and Brazil," she added.

Shares of No. 2 Banco de Chile dropped 3.66 percent, while shares of No. 3 bank Bci fell 1.26 percent.

TOUGH STAKE TO SWALLOW

The Bci brokerage said it believes the market could struggle to absorb the Santander Chile share sale, given its scale, market risk aversion and the sector's weak performance.

"On top of negative factors affecting the banking sector's performance of late, this now adds considerable selling pressure," Bci said in a note to investors. "It is pretty likely banking shares will be pressured lower on the stock market as a result of this adjustment."

European banks including BBVA , HSBC , Deutsche Bank , BNP Paribas and Rabo Bank also operate in the Latin America.

HSBC, Europe's biggest bank, announced in September it would sell its retail banking business in Chile to Banco Itau Chile as part of its plan to retreat from countries where it lacks scale.

HSBC plans to keep its investment banking and commercial operations in the country. It is planning to quit areas where it is not heavily represented or is struggling to compete, under a plan launched by new Chief Executive Stuart Gulliver in May to lift profitability and sharpen focus on Asia.