* New lending in CEE no longer capped at 110 pct of local financing
* That level now seen only as "alarm signal"
* Big three banks still need extra capital buffer by 2016
* Must meet Basel III rules in full by January 2013 (Adds EBRD reaction, background, shares)
By Michael Shields
VIENNA, March 14 (Reuters) - Austria's market watchdogs have softened guidelines to limit lending by three big Austrian banks' units in emerging European countries after international protests that the curbs could cause a credit squeeze in the region.
A proposal that UniCredit's Bank Austria unit, Erste Group Bank and Raiffeisen Zentralbank cap new central and eastern Europe lending at 110 percent of financing they arrange locally was diluted in the new standards.
Regulators now simply say they will monitor and analyse quarterly lending data.
"The analysis of past experience has shown that exceeding a reference ratio of 110 percent can be considered an alarm signal," a joint release from the FMA market regulator and central bank said on Wednesday.
"The results of this monitoring exercise will be discussed and assessed with the competent host and home supervisors in the supervisory colleges to agree on any necessary supervisory measures," the regulators added.
An FMA spokesman said Austrian regulators would discuss such cases with counterparts from emerging Europe and the European Banking Authority. That meant any remedial steps would be decided at a European, not Austrian, level.
Romanian President Traian Basescu and other officials had warned in November that the original curbs were unfair and could trigger a credit crunch in the region.
Others complained that Austria had not coordinated its action - launched as Vienna scrambled in vain to protect its AAA debt rating amid concerns about its large banking sector - with other countries in the region.
"These (guidelines) are an improvement relative to the first ones," said Piroska Nagy, a senior official at the European Bank for Reconstruction and Development.
One market expert who asked not to be identified said Austrian watchdogs now seemed to have got the message from supervisors in emerging Europe and the European Commission that Vienna could not go it alone in such matters.
Big Austrian banks - the leading lenders in central and eastern Europe - "are back on a level playing field with other European competitors", he said.
A spokeswoman for Raiffeisen Bank International (RBI), the listed unit of Raiffeisen Zentralbank, said the change in the lending guidelines to a monitoring approach could have a positive impact.
But it would not have had a problem even under the original rules because its lending in all markets in the region was at or below the 110 percent level, she added.
Governments, regulators and international agencies are trying to avert a stampede from the region, especially in Hungary and southeastern European countries that analysts say are most at risk of a banking crisis.
Under Austria's revised guidelines, the three banks will still need an extra capital buffer of up to 3 percentage points by 2016, the FMA and central bank said.
They must also meet Basel III banking industry capital rules in full by January 2013, six years ahead of schedule, to help boost the safety and sustainability of the financial system.
The RBI spokeswoman welcomed the fact that Austrian supervisors would accept as core Tier 1 capital the non-voting capital that banks got from the state and private investors during the 2008/09 financial crisis.
RBI shares were up 2.5 percent and Erste shares had gained 0.3 percent by 1520 GMT, while the Stoxx European bank sector index was up 1.4 percent. (Reporting by Angelika Gruber and Michael Shields; Editing by Will Waterman)