* Martin Wheatley had been due to step down in March 2016
* Sources say he quit after government didn't extendcontract
* FCA's Tracey McDermott to be acting chief executive (Adds lawmaker, banker reaction)
By Huw Jones
LONDON, July 17 (Reuters) - The head of Britain's financialwatchdog is stepping down early in a move some industry watcherssaid was a sign the government wants to take a lessconfrontational stance towards banks.
Sources familiar with the matter said Martin Wheatley,viewed as a hardliner in regulatory terms, had resigned as headof the Financial Conduct Authority (FCA) after the governmentrefused to extend his contract, due to end in March 2016.
In a statement on Friday, finance minister George Osbornepraised Wheatley for his work in launching the FCA in 2013 butsaid different leadership was required to take the watchdog tothe next stage of its development, without elaborating.
Barney Reynolds, a financial services lawyer at Shearman &Sterling, said the decision showed a change in tone fromministers.
"They want a slightly more business-friendly approach totake root and to rein back from some of the more hostileapproaches immediately post credit crunch," he said.
"This is very much welcome as the UK financial sector wasstarting to lose traction."
Having governed in coalition from 2010-15, Britain'spro-business Conservative Party won an outright majority in Mayelections. Osborne has since begun to sound more conciliatorytowards banks, talking of a new settlement with an industry thatis vital for UK economic growth and tax revenues.
After hefty taxes on banks and a raft of new regulations,financial services giant HSBC is reviewing whether tokeep its head office in London.
Wheatley, 56, warned banks in 2012 he would "shoot first andask questions later", a statement he later said he regretted.
He had to forgo his bonus for the 2013-14 financial yearafter the FCA was criticised for mishandling the announcement ofa review into life insurance policies.
The FCA has come under pressure from lawmakers to protectconsumers better after they suffered from three decades ofmis-selling scandals ranging from pensions to loan insurance.
John Mann, an opposition Labour member of parliament'sinfluential Treasury Select Committee which has grilled Wheatleyon his work, said Osborne was wrong to "sack" a regulator as itundermines the watchdog's independence.
WORLDWIDE SEARCH
"The government is launching a worldwide search; Martin'sreplacement will, like him, need to be passionate aboutprotecting consumers, promoting competition and completing thejob of cleaning up the City, so it is the best-regulated marketin the world," Osborne said in his statement, referring toLondon's finance district.
Osborne, who said last week he wanted regulators to focus onkeeping London as an attractive global financial centre, saidTracey McDermott, the FCA's head of wholesale marketsupervision, would take on the role of acting chief executive.
McDermott has been viewed internally at the FCA as a leadingcontender for the top job.
Britain's regulators were tarnished by the 2007-09 financialcrisis when undercapitalised banks had to be rescued bytaxpayers. The then Financial Services Authority was split intotwo, with the FCA having a remit to oversee markets and conduct,and the Bank of England supervising the solvency of banks.
"I am incredibly proud of all we have achieved together inbuilding the FCA over the last four years" Wheatley said in astatement.
Wheatley is a former deputy chief executive of the LondonStock Exchange who left to head Hong Kong's financial regulatorbefore returning to Britain to lead the FCA.
Under his watch, helped by McDermott's stint as head ofenforcement before she moved to supervision, the regulator haslevied record fines on banks after they were caught trying torig the Libor interest rate benchmark and currency markets.
He has said repeatedly that the job of improving standardsat all levels of banks is far from finished but dismissedindustry accusations he was only interested in "heads onsticks".
Anthony Browne, chief executive of the British Bankers'Association said Wheatley had been "firm, fair and sensible". (Additional reporting by David Milliken; Editing by Keith Weirand Mark Potter)
HSBC Holdings (HSBA)