UPDATE 2-UK regulator says worse may be yet to come for banks
* UK watchdog to further refine bank capital guidelines
* Bankers say regulatory messages are mixed
* Tucker wants fixed basic capital requirements as backstop
* Tucker says bankers could be partly paid in bank debt
LONDON, Oct 17 (Reuters) - The worst may be yet to come for Britain's banks as they are still not strong enough to cope with another financial meltdown, a top regulator warned the country's bankers on Wednesday.
"We are in very difficult circumstances in the sense that huge risks are behind us (but) there is still a tangible probability - not a high probability - that the worst may still be ahead," said Paul Tucker, deputy governor of the Bank of England.
"Basel I, II, III, IV and V are not calibrated for the kind of end of the world risks that lie within the realms of the possible at the moment," he told the British Bankers' Association's annual conference in London on Wednesday.
British banks have already been forced to build up large capital defences since the beginning of the financial crisis in 2007, and are caught between regulators' conflicting advice to trim surplus reserves while acquiring more capital.
In September, the Bank of England's Financial Policy Committee said banks could trim reserves if they lent to businesses but that they should also build up core defences, by cutting bonuses if need be.
Tucker also warned of a huge public backlash if banks - such as Royal Bank of Scotland and Lloyds which were rescued by taxpayers in 2008 - needed to be bailed out again.
Although British banks' reserves are now above the minimum international standards known as Basel III that are being phased in from January, Tucker - the top contender to succeed Mervyn King as BoE governor next year - said banks should go further.
"If we get a tidal wave, we may all be grateful that there are a few billion more in capital here and there in the banking industry, keeping banks in the private sector rather than the dead hand of state ownership," he said.
But Andrew Bailey, head of banking supervision at the Financial Services Authority, said the BoE's Financial Policy Committee (FPC) was struggling to send a clear message to banks on how big capital defences needed to be.
The FPC needed to fill in "what for me is the big gap at present, namely how we explain and calibrate the resilience objective in terms of capital," Bailey said.
Tucker added it was not "safe" to continue allowing banks to calculate their own capital buffers using in-house computer models, and called on global regulators to consider mandatory fixed amounts of capital instead as in the United States.
He also backed forcing top bankers to have some of their bonus in the form of their bank's debt, meaning they would bear losses to help with any bailout of the bank.
Bailey said the FSA still required banks to build up their core Tier 1 ratios - a benchmark of a bank's health - in line with Basel III, but would allow them to scale back the capital they hold above the regulatory minimum, know as Pillar 2.
Since 2008, this Pillar 2 capital has risen from just under 20 billion pounds ($33 billion) to 150 billion pounds.
Regulators are trying to restore trust in banks already battered by mis-selling scandals, tougher rules and the record $450 million fine for Barclays in June for trying to manipulate the London Interbank Offered Rate (Libor).
The government said on Wednesday it would change the law to make the rigging of market benchmarks illegal and strip the BBA of its role as Libor administrator.
BBA Chief Executive Anthony Browne said a survey showed only 28 percent of the public trusted high street banks.
"If there is one good thing to come out of Libor, it is that there is now clear determination from the top of the industry that they must do whatever it takes for banks to win back their place in society," he said.
Bankers recognise that the "good cop, bad cop" message from regulators was partly down to the FPC's dual supervisory role of monitoring economic growth as well as maintaining financial stability, two remits that often contradict each other.
"It shows that supervision is an art and not a science," said Paul Chisnall, executive director of the BBA. "The process of supervision is evolving. There is a new dynamic between the overall level of capital in the financial system and the ability to adapt this to give some assistance to help the economy."
However Rolls Royce Finance Director Mark Morris said regulators had not yet got the balance right for business. "We feel (it) is being overlooked more in favour of regulation rather than growth," he told the BBA event.
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