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.