UPDATE 2-UK watchdog seeks payment protection restrictions

* Wants 14-day PPI sales hiatus for lenders

* Seeks ban on single premium PPI policies

* ABI, BBA say proposals could harm consumers

(Adds comment from BBA, Moneynet.co.uk)

LONDON, Nov 13 (Reuters) - British lenders would be banned from selling payment protection insurance (PPI) to borrowers within 14 days of them taking out a loan, under proposals set out on Thursday by the country's competition regulator.

The Competition Commission also proposed a ban on single premium PPI policies, and said lenders should be obliged to provide borrowers with a separate quote for the cost of PPI.

The watchdog said the measures are aimed at overcoming a lack of competition in the market for PPI, which allows borrowers to keep up loan repayments in the event of an unexpected loss of income.

PPI sales generated premium income of 4.4 billion pounds in 2006, according to Competition Commission data.

Banking and insurance industry representatives on Thursday attacked the Commission's proposals, saying they could leave borrowers unprotected just as unemployment is rising sharply.

Nick Starling, ABI Director of General Insurance and Health, said: "By effectively denying consumers PPI in the very economic climate that they need it most, the Competition Commission has got this completely wrong."

In a statement, the British Bankers' Association said: "This is an irresponsible decision exposing vulnerable customers to economic difficulty when they may need help most."

The Commission began an investigation into PPI in February 2007, and in June this year reported that lenders face "little or no competition" when selling PPI to their customers.

The watchdog said the chief obstacle to greater competition in the sector was lenders' "point of sale" advantage, with most PPI sales taking place at the same time as consumers receive their loan.

The Commission said the proposed 14-day sales hiatus is designed to encourage consumers interested in buying PPI to shop around for cheaper deals.

A Commission spokesman denied that the measures would prevent consumers from buying PPI.

"There is nothing in our proposals that would stop or discourage people from taking out the cover," he said.

A spokesman for financial services comparison site Moneynet.co.uk welcomed the proposed rules, saying they would make it easier for consumers to decide whether or not to buy PPI.

"This will give consumers the opportunity to weigh up the costs and benefits of such cover without feeling pressured by frontline staff with one eye on their monthly sales targets," the spokesman said.

The Commission launched its investigation into PPI at the request of the Office of Fair Trading, which had launched its own probe into the market after receiving complaints about the product from consumer information service Citizens Advice.

The regulator's proposals are open for consultation until Dec. 4, with final measures to be unveiled in mid-January.

Analysts said the proposed PPI restrictions contributed to a drop in UK bank share prices on Thursday, with shares in Royal Bank of Scotland (RBS.L) down 6.43 percent and HBOS HBOS.L down 5.99 percent at 1258 GMT.

(Reporting by Myles Neligan; Editing by Sharon Lindores)