UK risk watchdog set to ease bank buffers LONDON (Reuters) - The Bank of England's risk watchdog looks set to allow lenders next week to free up billions of pounds from their cash buffers and help haul the economy out of recession. The Financial Policy Committee (FPC) meets on Friday and publishes recommendations for regulatory action on June 29. Some members have dropped heavy hints on what to expect as part of a wider UK effort to get more credit flowing into companies. The FPC, chaired by BoE Governor Mervyn King, is tasked with spotting broad risks such as asset bubbles that could destabilize the financial system. It plugs a pre-crisis supervisory gap and advises on action regulators should take. King said last week "the need for banks to hold large liquid asset buffers is much diminished, and I hope regulators around the world will take note." His deputy, Paul Tucker, also an FPC member, said regulators should see whether they can liberate this part of banks' balance sheet in these stressed times. Tucker also said requiring hefty buffers stops the economy from getting the full benefit of the Bank's 325 billion pound quantitative easing program of UK government bond purchases. The buffers ensure banks have enough funding if markets suddenly dried up, an event which forced Britain to nationalize Northern Rock bank in the 2007-09 crisis. "Excessive liquidity requirements have a negative impact on the ability and willingness of banks to expand their balance sheets," said Michael Lever, managing director at banking-lobby Association for Financial Markets in Europe (AFME). "So if they were partially relaxed, then it would give banks increased flexibility to support lending and economic recovery," Lever said. The sums freed could be huge as Barclays (BARC.L) alone held 170 billion pounds of liquidity - as opposed to separate capital buffers - in the first quarter. An industry official estimates the big four banks combined, the others are HSBC (HSBA.L), Lloyds (LLOY.L) and Royal Bank of Scotland (RBS.L), hold 650 to 700 billion pounds in liquidity. A rowback of 20-30 percent, the magnitude experts say would have an impact, would release 150-200 billion pounds for use though bankers warn privately there is no guarantee freed up cash would end up in the pockets of credit-starved companies. In particular small firms have long complained about the difficulty to get credit and BoE monetary policymaker Martin Weale warned on Thursday that the high effective interest rates and credit rationing were factors depressing the economy. Britain was the first to force lenders to build up liquidity buffers, well ahead of global rules that don't start until 2015, thereby giving UK regulators wiggle room. An easing of banks' buffers would dovetail with a wider UK initiative announced by King and Osborne last week to spur the flow of credit. The FPC has been set up on an interim basis but will have formal powers from next year to order regulators to take action such as forcing banks to hold more capital. The regulatory shift comes as finance minister George Osborne plans to widen the FPC's remit to include a "secondary objective" of supporting economic policy. The existing remit is to promote financial stability without harming the economy but bankers say the wider remit to actively help the economy will give the FPC second thoughts on taking draconian measures. Simon Hills of the British Bankers' Association welcomed the BoE's decision this week to give banks 5 billion pounds of low-interest six-month loans as a flavor of what's to come. "It is the first tangible evidence the Bank is responding to the FPC's mandate to include economic growth in the factors it considers," Hills said. The FPC has been split for a year over whether it should help the economy by using its so-called macroprudential tools to lower bank capital and liquidity levels. Britain's return to recession and heightened euro zone debt crisis appears to have settled the debate. FPC member and Financial Services Authority Chairman Adair Turner, likens it to pouring a tot of alcohol into the punchbowl to get the party going again but concedes this may be "pushing on a string," meaning difficult to do in practice. Etay Katz, a financial lawyer at Allen & Overy in London, said widening the FPC's remit to touch on monetary policy would be undesirable and create a conflicting agenda. Reporting by Huw Jones