* Plans to take advantage of lighter capital rules
* New bank to offer personal loans, car loans
* New bank to be deposit-funded
* H1 underlying profit 48.2 mln stg, below forecasts (Releads with CEO comments on setting up bank, adds shares)
By Matt Scuffham
LONDON, May 21 (Reuters) - British buy-to-let mortgage provider Paragon plans to set up a bank next year, taking advantage of new rules designed to encourage competition to Britain's established lenders.
Under pressure from lawmakers to increase choice in a sector dominated by five banks, Britain's financial regulator said in March that start-up banks would no longer need as much capital as their established rivals.
Chief Executive Nigel Terrington said on Tuesday the change had prompted Paragon to end talks to buy the National Counties Building Society and to apply for a banking licence instead.
"We'd already decided to pursue the consumer finance market through a banking route," he said. "At one point we were pursuing entry via an acquisition but we changed that plan to go the organic route," he told Reuters in an interview.
Capital requirements will be lighter for the first three to five years as long as a new bank can show deposits are insured and that it can be wound up without destabilising markets.
Terrington said Paragon's bank would launch in 2014, offering deposit-funded consumer finance lending including personal loans and car loans.
New banks have slowly begun to surface since the 2008 financial crisis, looking to fill the gap as Britain's biggest lenders focus on shrinking their balance sheets and building up capital to meet new regulations.
Most of the challengers, such as Aldermore and Shawbrook, are not looking to offer all banking services, but are instead focusing on particular areas of the market where they believe they can compete with larger operators.
Paragon posted a 10 percent increase in underlying pretax profit in the first half of its fiscal year, but that missed market expectations and its shares, up over 90 percent since the start of 2012, were down 3.6 percent at 0915 GMT.
Paragon reported an underlying pretax profit of 48.2 million pounds ($73.4 million) in the six months to the end of March, boosted by profits from newly acquired loan portfolios. Analysts' average forecast had stood at 50.25 million pounds, according to Thomson Reuters I/B/E/S data.
Terrington said not all of the benefit of recent acquisitions had come through and was "comfortable" with the average profit forecast of 103 million pounds for the full year.
Paragon has performed strongly during the economic downturn with buy-to-let mortgages in demand as landlords take advantage of a booming rental market while first-time home buyers struggle to get on the housing ladder. The company has also expanded through acquisitions as mainstream lenders sell off loans.
Paragon granted loans worth 102.3 million pounds during the period, up from 89.2 million the year before.
$1 = 0.6570 British pounds Reporting by Matt Scuffham, Editing by Brenda Goh and Mark Potter