* FTSEurofirst 300 falls 1.3 pct; Euro STOXX 50 down 1.4 pct
* Commerzbank falls 5.3 pct on U.S. settlement fears
* Austrian banks hit by CEE exposure, investor haircut (Updates with closing prices and no other changes to text)
By Alistair Smout
EDINBURGH, July 8 Banking stocks led European shares lower on Tuesday as German banks became the latest lenders to be negotiating a costly legal settlement with U.S. authorities.
At the close, the pan-European FTSEurofirst 300 index was down 1.3 percent at 1,363.46 points, extending losses in afternoon trade in line with US stocks.
Euro zone banks fell 2.8 percent, the biggest sectoral faller, led lower by Commerzbank.
Shares in the German lender fell 5.6 percent as sources told Reuters that U.S. authorities had begun settlement talks with the bank and its larger rival Deutsche Bank, down 2.1 percent, over their dealings with countries blacklisted by the United States.
The New York Times reported that Commerzbank's settlement was expected to include at least $500 million in penalties. This compares with a settlement of almost $9 billion France's BNP Paribas struck in a similar case earlier this year.
"Stories about banks getting embroiled in regulatory investigations will be the new narrative for quite some time," Michael Hewson, chief market analyst at CMC Markets, said.
Mike Reuter, a broker at Tradition, said a fine of up to around one billion dollars would be accepted by the market.
"Unless they get a very big fine like BNP, I don't think it will suffer like the other banks (hit by U.S. investigations)," he said.
Austrian banks were also under pressure, with Erste Group down 1.8 percent and Raiffeisen Bank down 6 percent.
Erste was downgraded by Goldman Sachs, Citi and Deutsche Bank on Tuesday after last week's profit warning, and traders said that exposure to weakening markets in eastern Europe could hinder the country's banking sector.
New Hungarian legislation to compensate borrowers for unfavourable interest rates will require "material capital injections" from the foreign parents of banks operating the country, ratings agency Fitch said on Tuesday.
"The central and eastern European exposure of Austrian banks is a big issue. Raiffeisen in particular has a very large exposure there, and the economy in the region has problems," said Mike Ingram, a market analyst at BGC Partners. "Banks generally have been struggling."
The lower house of the Austrian parliament also approved legislation to wipe out some subordinated creditors of nationalised bank Hypo Alpe Adria, in a move that ratings agencies said was a dangerous precedent.
The Euro STOXX 50 index was down 1.4 percent at 3,184.38 points, taking its fall over the last three days to 3.2 percent and leaving the index at its lowest since late May.
The index has been marking higher lows since December but on Monday it broke below its 50-day moving average, in what is often considered a bearish technical signal.
"Our view on the Euro STOXX 50 is still bullish as prices remain above a strong ascending trend line drawn from December 2013 (currently at 3,080 points)," Philippe Delabarre, an analyst at Trading Central, said.
"Nevertheless, yesterday, the break below the 50-day simple moving average was the first weakness signal. Our targets remain 3,330 and 3,440 points as long as 3,080 is a support threshold."
Europe bourses in 2014: link.reuters.com/pap87v
Asset performance in 2014: link.reuters.com/gap87v
Today's European research round-up (Additional reporting by Francesco Canepa, editing by Larry king)