UPDATE 3-China Merchants Securities to launch IPO this week

* IPO could raise up to $2 bln - analyst

* Merchants Securities to issue up to 360 million A shares

* China IPOs set to return to normal as markets stabilise (Rewrites with details, analyst comments)

By Samuel Shen and Edmund Klamann

SHANGHAI, Nov 3 (Reuters) - China Merchants Securities Co won regulatory approval for an initial public offering in Shanghai that could fetch $2 billion, setting off a return of big IPOs to the mainland stock market after share prices stabilised.

The planned IPO, potentially the biggest in nearly two months, comes after the successful launch of China's Nasdaq-style second board last week and as the broad market gains strength after a 22 percent slump in August.

"The slump was caused partly by fears of equity oversupply," said Wei Tao, analyst at China Securities Co. "Now that the market is stabilising and the second board has been successfully launched, it's natural for regulators to start letting major IPOs come to market again."

China has seen no big IPOs since September, when Metallurgical Corp of China (MCC) (1618.HK) 601688.SS raised $5.1 billion in Shanghai and Hong Kong.

Merchant Securities, a medium-sized brokerage, is proceeding with its long-delayed IPO to capitalise on a more than 70 percent rally in China's stock market this year, which followed last year's 65 percent tumble.

That rally abruptly reversed course in August, however, due largely to stretched valuations and shrinking liquidity as a bank lending boom ebbed, but also to concerns about share supplies fed by big IPOs and the launch of ChiNext, China's second board. [ID:nSHA201386].

The Shanghai Composite Index .SSEC has since rebounded nearly 20 percent from its September lows and rose 1.2 percent on Tuesday despite news of the IPO.

"Now that liquidity concerns are gone, IPOs and fund-raising activities are back to normal," said Zhang Fan, an analyst at Changjiang Securities Co. "Regulators are obviously confident now that the market can handle big IPOs."

NEED TO EXPAND

Merchant Securities, in only the third IPO in the mainland markets by a Chinese brokerage, plans to sell up to 360 million yuan-denominated A shares, or 10 percent of its expanded capital, it said in a share sale prospectus on Tuesday.

It would use the proceeds to supplement operational capital, including expansion in asset management, investment banking, private equity investment, brokerage and proprietary businesses.

"Brokerages need to take advantage of the market revival to boost capital and expand," said Tian Hui, analyst at Industrial Securities Co. "If you don't grow your businesses and get stronger, you'll be eliminated in market competition."