UPDATE 2-UK banks allowed to cut their cash holdings

* Carney says no mission accomplished in fixing banks

* Regulators give banks more flexibility over cash buffers

By Huw Jones

LONDON, Aug 28 (Reuters) - Britain's eight top lenders cancut their cash reserves by a collective 90 billion pounds ($140billion) and use the funds to support economic growth, the Bankof England's new governor Mark Carney said on Wednesday.

Britain's lenders were forced to build up buffers of cashand UK government bonds far earlier than required under aglobally-agreed timetable.

The buffers help cushion them from short-term market shocksso they can keep operating for a month even if markets freeze,as they did during the 2007-09 financial crisis.

UK government bonds, known as gilts, fell after Carney'sannouncement as investors factored in the likelihood that thebanks will sell off some of their holdings.

Carney, in his maiden speech as governor of the Bank ofEngland, said it "will help to underpin the supply of credit,since every pound currently held in liquid assets is a poundthat could be lent to the real economy".

In a separate statement, the central bank's PrudentialRegulation Authority, which supervises UK lenders, said bankscould scale back the liquidity buffers on condition they have aseparate, minimum core capital ratio of 7 percent - a newrequirement.

The watchdog has said it expects the lenders to meet thiscapital ratio by the end of the year after some had to takesteps to find more capital.

The eight are: HSBC, Barclays, Co-op,Lloyds, RBS, Standard Chartered,Santander UK and Nationwide.

The PRA is implementing a policy that the BoE's FinancialPolicy Committee decided on in June. The policy would allow thefour biggest banks to scale back their liquidity buffers to 80percent of where they should be if in full compliance with theglobal Basel III accord, not due until 2018.

This would release 70 billion pounds but, by extending thechange to the eight main lenders, a further 20 billion poundscan potentially be released.

The British Bankers' Association said banks would bere-assessing how much of the 90 billion pounds can be redeployedinto lending to small and medium businesses and households, asthey are committed to doing.

NO MISSION ACCOMPLISHED

The banks are under political pressure to increase lendingto business following criticism that they are focusing on homemortgages and consumer credit rather than productive industry,encouraging a lop-sided economic recovery.

The banks argue that lending levels reflect the amount ofdemand.

Carney signalled that banks face having to hold more capitalagainst mortgages if house price growth becomes unsustainable.

Like his predecessor Mervyn King, he insisted thatwell-capitalised banks are in a better position to lend, sayingU.S. banks have rebuilt their capital bases and now lend farmore than their British peers.

But Carney avoided some of King's harsh rhetoric towards theBritish banks, striking a more conciliatory tone that waswelcomed by Philip Hampton, chairman of Royal Bank of Scotland,during a visit to Reuters.

"Most people like Mark Carney and they think they can dobusiness sensibly with him," Hampton said.

Britain's banks will face further capital requirementsbecause of their size or market dominance, but Carney said histask would be to manage this transition "in a gradual way thatsupports continued confidence in growth".

With a 7 percent core capital ratio, banks would be"adequately capitalised" to start that transition, he said.

"There is no mission accomplished banner that the bankingsystem is fixed," Carney added.

Banks have been using cash and top-quality government bondssuch as UK gilts in their liquidity buffers. The PRA said onWednesday that up to 40 percent of the buffers could in futurebe in corporate bonds, shares and retail mortgage-backedsecurities, giving them greater flexibility.

$1 = 0.6435 British pounds)