PREVIEW-Financial re-regulation set to start in EU

* EU executive to unveil tougher bank capital rules

* Risky mortgage-backed assets targeted

* Streamlining cross-border bank supervision controversial

By Huw Jones

BRUSSELS, Sept 29 (Reuters) - Financial re-regulation starts in the European Union this week with draft proposals that will force banks to tie up more capital to cover risky activities and apply lessons learnt from the credit crunch.

The weekend rescue of Benelux banking and insurance group Fortis (FOR.BR) also looms large over the rules, which seek to tackle problems more quickly and better protect depositors by streamlining oversight of banks operating in several EU states.

On Wednesday EU Internal Market Commissioner Charlie McCreevy will unveil his long-awaited reform of the 27-nation bloc's banking capital requirements, affecting some 8,000 banks.

Work on the reform began before the U.S. home loan crisis in August 2007 snowballed into a global credit crunch, but the need to rescue banks with large exposures to toxic securitised products has made the reform more pressing.

EU states have agreed in principle to adopt the reform proposal -- made up of three key elements -- quickly, but final details may still be changed.

McCreevy will insist banks that turn loans into debt for sale, such as mortgage-backed securities, must retain at least 5 percent, an EU diplomatic source told Reuters last week.

The U.S. Treasury has set up a $700 billion fund to buy such products in order to make it easier for banks to raise capital.

McCreevy believes it would give banks an incentive to make sure their securitised products are based on solid assets rather than home loans with defaults a high probability.

But as this 5 percent provision has not undergone a cost-benefit study, it may eventually be ditched by the European Parliament and EU states, which have the final say.

A second provision introduces the need for a bank to set aside capital to cover exposures to another bank. McCreevy has pegged this at 25 percent above a certain threshold.

Smaller banks in Britain and Spain are likely to resist, seeing this as too burdensome.

The final provision would introduce colleges of supervisors for each major cross-border bank whose failure would put the wider financial system at risk.

The college, made up of supervisors from all EU countries where a bank operates, would oversee day-to-day operations and step in to consult if there was a crisis. Such a system existed for Fortis and is seen as helping the bank's speedy rescue by the Benelux states.

EU ministers meeting in Nice, France this month agreed in principle that the supervisor of a bank's home country should take the lead but some states may resist this.

McCreevy told reporters on Monday that despite previous calls for an adequate supervisory structure for cross-border financial institutions "it is particularly difficult to get agreement among the member states who want to preserve the control of supervision within their own member states."

Some investment banks that originate securitised products have said McCreevy's 5 percent retention target is overkill. The broader banking industry, however, accepts tougher rules are inevitable given public outcry over the huge recourse to taxpayers' money to shore up the industry.

"There are no issues we cannot live with," Guido Ravoet, secretary general of the European Banking Federation, told Reuters.

He urged EU states to make a bank's home supervisor the lead regulator in a college when there is no consensus. He said such a move would be more efficient.

The financial industry will face more regulation later this month when McCreevy comes out with his proposals to regulate credit rating agencies directly for the first time in the EU.

EU president France and many EU lawmakers on the left are calling on McCreevy to do more, though he remains resistant.

"We have been examining, say, the possibility of new rules but no new rules today are going to get over the problems of yesterday," McCreevy said. (Additional reporting by Jan Strupczewski in Brussels and Jonathan Saul in Dublin; Editing by Sharon Lindores)