(Writes through, adds detail and background throughout) LONDON, Jan 7 (Reuters) - French bank stocks helped lead asector-wide surge on Monday after regulators softened anddelayed new liquidity rules, easing pressure on lenders toconform and potentially giving some a big profit boost. Europe's banking index was up 1.6 percent at 172.4points by 1000 GMT, after racing to 173.7, its highest in 17months. French lenders BNP Paribas and Credit Agricole rose more than 2 percent and there were similar gainsin Italy's Unicredit, Britain's Barclays andGermany's Deutsche Bank. Global regulators on Sunday gave banks four more years andgreater flexibility to improve their funding positions, due tofears that a draconian earlier draft would have choked economicrecovery. The pullback from the original liquidity coverage ratio(LCR) draft went further than many analysts had expected. Most banks should have no problem meeting the easierstandards when they are phased in from 2015 and will have timeto build up to full implementation in 2019, which could havebeen a challenge for some major French and German banks andothers in the euro zone, analysts said. "The announced changes represent a more significantrelaxation of the contentious new liquidity rule than had beenanticipated," said Michael Symonds, credit analyst forfinancials at Daiwa Capital Markets Europe. "The more pragmatic approach from regulators is warranted... the easing recognises that the torrent of new regulationoriginating from the first phase of the financial crisis hassomewhat weighed on economic recovery, in particular in Europe,"he said. LOW YIELD Banks like Societe Generale, Credit Agricole andCommerzbank h ad faced having to build up far biggerholdings of low-risk and low-yielding government bonds, so therelaxation in rules should cut the increase in interest ratesthey faced. Stronger banks should benefit too, as they can reduce thesurplus liquidity they hold, allowing them to cut interest costsby shifting from cash or governments bonds into assets that payhigher interest. Barclays, for example, had a liquidity pool of 160 billionpounds at the end of September, giving it an LCR of just below100 percent under Basel III rules. Under the relaxed rules, 30billion pounds of that could be considered surplus liquidity andcould release about 300 million pounds in annual interest costs,analysts at Espirito Santo estimated. Banks had complained they could not meet the January 2015deadline to full comply with the new rule on minimum holdings ofeasily sellable assets and at the same time supply credit tobusinesses and consumers. As well as delaying implementation, the Basel Committeewidened the range of assets banks can put in the buffer toinclude shares and retail mortgage-backed securities (RMBS), aswell as lower-rated company bonds. (Reporting by Steve Slater, Simon Jessop and Francesca Landini;Editing by David Holmes)