Regulators have few powers to stop banks from calling in loans to comply with tougher capital standards, Britain's financial watchdog said on Thursday.

EU leaders agreed last month banks must comply with higher capital standards by next year in a bid to restore investor confidence in a sector battered by the euro zone debt crisis.

The European Banking Authority (EBA) wants banks to meet the new rules by curbing bonuses and dividends and avoiding deleveraging or scaling back loans, which would crimp an already stumbling European economy.

Financial Services Authority Chairman Adair Turner said if banks are deleveraging, he would prefer to see it done in interbank trading rather than lending operations.

There may be little regulators can do, however.

It's true to say that tools you have as a regulator to give effect to that are somewhat limited, Turner told a panel of lawmakers.

The government's Project Merlin has sought to put pressure on banks to keep lending to businesses.

EU financial services chief Michel Barnier said this week he will propose a law to empower supervisors to push banks that need to beef up their capital into curbing payouts like bonuses.

FSA Chief Executive Hector Sants told the lawmakers he was a strong supporter of the EU plans to shore up banks, which did not require UK lenders to take any action.

Sants said his conversations with non-UK banks showed they were in any case going through a deleveraging process because of the funding challenges they faced.

Without agreement among EU leaders and the EBA on extra bank capitalisation there could have been worse deleveraging as lenders faced deepening funding stresses, Turner said.

The Bank of England's Financial Policy Committee (FPC), of which Turner is a member, has debated whether lenders should be allowed to run down their capital buffers to keep credit flowing to businesses, Turner added.

EU LAW HURDLE

Turner reiterated his hardline stance on bank capital, saying there is a reasonable case that globally agreed rules to safeguard against trading risks were not tough enough.

Also the new Basel III global bank capital accord introduces a capital surcharge of up to 2.5 percent in times of frothy credit markets.

Turner said we can imagine we might want to use that beyond the 2.5 percent.

He repeated Britain's opposition to a measure that will turn Basel III into EU law as it states the new capital standards are a maximum rather than minimum.

Turner gave a 5 out of 10 mark for the extent he was optimistic the EU law will give Britain enough flexibility to impose heavier capital requirements on some of its banks.

Sants said the measure threatens the FPC's ability to meet its financial stability mandate.

It was vitally important the UK government takes the lead in Britain to influence EU financial regulation, Sants added.

Nearly all the rules UK regulators enforce will come from the EU accessed by me on a computer, Sants said.

Britain was outvoted on Thursday over new rules that will give an EU watchdog powers to force a member state like Britain to introduce a shortselling ban on shares and bonds even if it does not want this.

Turner said the FSA will shortly publish its report into the rescue of Royal Bank of Scotland .

He said in June the report will show regulators were severely deficient in how they supervised the troubled bank.

(Editing by David Cowell)