UPDATE 2-Spain imposes short-selling ban on Liberbank to prevent 'domino effect'

* EU agency ESMA - move was to stem threat to financial stability

* Liberbank stock recovers after short-selling ban

* Regulator sees no liquidity stress at bank - source (Updates with regulator statement and source)

MADRID/ FRANKFURT, June 12 (Reuters) - Spanish regulators imposed a short-selling ban on Liberbank on Monday in order to stem what European authorities described as a potential ‘domino effect’ that could have damaged the country’s entire banking system.

Last week, European authorities orchestrated a rescue of Spain’s Banco Popular, a move that resulted in heavy losses for shareholders and some bond investors.

That in turn prompted a steep fall in the share price of a small Spanish lender, Liberbank, wiping almost half of the bank’s market value.

On Monday morning, Spanish stock market regulator CNMV said it would ban short selling in Liberbank stock for one month.

A CNMV official said it wanted to avoid any loss of confidence in Liberbank and that the regulator was not considering extending the ban to other lenders for now.

The European Securities and Markets Authority (ESMA) also issued a detailed statement that backed the move, explaining the urgent circumstances that led to it.

ESMA said that the step had been needed, in the eyes of Spanish authorities, to tackle the threat to market confidence that “could have further implications in terms of financial stability in Spain” following the ‘demise’ of Banco Popular.

“Due to the interconnections and perceived similarities with other entities, the situation could have a domino effect of a size that could become systemic,” ESMA said, warning of a ‘contagion’ that can hurt the entire financial system.

The announcement of the ban led to a rebound in the share price of the lender that was formed in 2011 from the merger of three regional savings banks and which controls around two percent of all Spanish deposits.

The stock rebounded more than 20 percent. Its shares were up 28.4 percent at 0.873 euro at 0906 GMT. The Spanish regulator said it would decide later whether or not to extend the ban beyond one month.

The CNMV said it had taken this decision after the recent stock price fall of Liberbank in the aftermath of Popular’s rescue.

But it sought to draw a distiction between the two banks. One official said that Liberbank’s situation was different to Popular, whose finances had been stressed.

Banco Popular, which had booked revised losses of 3.6 billion euros ($4 billion) in 2016, was rescued after the ECB said there was a deterioration in its liquidity in the days leading to its rescue.

The official from the stock market regulator said they had not found any evidence of any liquidity problems at Liberbank.

Regulators took the action even though there were few betting on a further fall in the bank’s stock. ESMA said that in early June, short positions accounted for around 1.4 percent of its capital.

“Without the proposed measure, the threat to market confidence would remain and would be difficult to tackle,” ESMA wrote.

Short selling is the sale of a security that is not owned by the seller, or that the seller has borrowed, and motivated by the belief that a security’s price will decline, enabling it to be bought back at a lower price to make a profit. ($1 = 0.8911 euros) (Additional reporting by Robert Hetz and Gdynia newsroom; Editing by Julien Toyer and Louise Heavens)