* Central banks faced funding banks indefinitely
* Minds changed after 1 trln euro ECB operations-sources
* Banks staged low-key lobbying after Dimon row
* Fine print shows banks didn't get all their way
By Huw Jones and Lionel Laurent
LONDON/PARIS, Jan 21 (Reuters) - Lobbyists found themselves preaching to the converted: the European Central Bank and Bank of England needed little persuading in the end that new global liquidity rules for commercial banks needed loosening.
Central bankers realised they had to relent unless they wanted to remain cash machines for squeezed European lenders indefinitely, said sources close to negotiations on the rules.
Earlier this month, commercial banks got their way after a campaign whose subtlety contrasted to past aggressive and unsuccessful lobbying efforts.
Global regulators gave them four more years and greater flexibility to build up sufficient liquid reserves - those that can be sold quickly for cash even during crises - so that taxpayers would no longer have to fund rescues like in 2007-09.
"What helped the ECB and Bank of England rally to European banks' cause was the realisation that liquidity deficits were a central bank issue," said a banking source close to the talks.
"The change in their minds happened around the middle of last year," said the source, who declined to be named because he was not authorised to speak publicly about the talks.
While the banking crisis late last decade was global, European lenders now need the relief on the liquidity rules most due to weak economies across the euro zone and Britain.
The rethink followed the ECB pumping roughly 1 trillion euros ($1.3 trillion) of liquidity into banks in two stages late in 2011 and early last year. The operation flooded the banks with cheap three-year loans, allowing them to buy assets such as bonds of stressed euro zone governments.
But the risk was that as central banks gave with one hand, the Basel Committee of regulators would effectively take away with the other. The rules, had they not been eased, would have tied up huge sums in bank reserves - money that would no longer be available to lend into the economy and encourage growth.
"The biggest change is that they have cut the size of the liquid assets buffers," said Patricia Jackson, a former Basel Committee member. "They were going to be enormous, some 1.5 to 2 trillion euros would have to be held across Europe, but now they will be significantly smaller," said Jackson, who is now a consultant with Ernst & Young,
Usually a regulatory hawk, the Bank of England also softened its stand as it began worrying that the tough rules would prevent banks from financing a global recovery. "As usual they are very pragmatic and happily swung from one extreme to the other in the negotiations," said the source.
Bank of England Governor Mervyn King, who chairs the Basel Committee's oversight body, has said the changes make the rule more realistic, a view shared by ECB President Mario Draghi.
The BoE had no further comment and the Basel Committee declined to comment about the negotiations leading to the changes in the liquidity rule. However, King has said the new structure should ensure "central banks are asked to perform only as lenders of last resort and not as lenders of first resort".
The Basel Committee, the global standard-setter on bank capital, wants lenders to be able to survive 30 days of heavy deposit outflows - a run on the bank - on their own. This rule responds to the 2007-09 financial crisis, aiming to avoid taxpayers having to rescue banks as they had to with Britain's Northern Rock and others.
King's oversight body agreed to phase in the rule from 2015 over four years and widen the range of assets banks can put in the buffer to include shares and mortgage-backed securities, as well as lower-rated company bonds.
This marked a significant move from the draft version two years ago, which foresaw banks meeting the targets in 2015 solely with higher-rated assets such as government bonds.
The banks' mounted a low-key, technically-driven lobbying campaign to persuade the Basel Committee to allow more leeway on building up the costly cash buffers and on the "stress tests" which gauge whether they would be enough during crises.
"There was a constant dialogue of a fairly technical nature," said one U.S. banking official, who declined to be named. "We tried to keep in a positive and technical mode, the need to get it right, to realistically reflect what a conservative stress test should look like and being aware of the impact on the real economy."
The banks rejected high-profile speeches and public lobbying after similar tactics by Jamie Dimon, the chief executive of JP Morgan, scored a public relations own-goal in 2011.
Dimon launched a well-documented attack on Mark Carney, the governor of the Bank of Canada, accusing him of pushing new global bank capital rules that were "anti-American".
"People realised it was a backfiring strategy and it definitely backfired on Jamie Dimon," said a source familiar with Carney.
"Carney certainly laid down a marker, that they weren't going to be pushed around," said the source, who declined to be identified because of the sensitivity of the subject.
Carney's powers grew as he went on to become head of the Financial Stability Board - the regulation task force of the Group of 20 leading developed and emerging economies, which coordinates the work of the Basel Committee.
G20 leaders endorsed the principle of a liquidity rule in 2010, leaving banks room only to battle over finer technical details which are typically handled at a lower level. Carney himself replaces King at the Bank of England later this year.
Initially hailed as a triumph for lenders, the fine print underpinning the Basel Committee concessions show that the banks have not had it all their own way.
The committee, made up of regulators and central bankers from nearly 30 countries, attached stringent conditions to the inclusion of mortgage bonds, blue chip equities and mid-grade corporate bonds in the liquidity buffer.
This flexibility with tough conditions suggests a compromise to satisfy the U.S. and British regulatory hawks as well as the more accommodating continental European supervisors.
The commercial banks had no common global cause on the liquidity rules, so they tended to focus lobbying on their own regulators and monetary authorities rather than creating a cross-border alliance.
The French, whose loan structures meant they had specific problems with the liquidity rules, were the most vocal and their regulator fought their corner in the talks. Crucially, euro zone paymaster Germany was also open to a longer phase-in, meaning the three biggest EU members all favoured easing the rules.
"Some of the continental European regulators were sympathetic to us but some regulators do tend to have ulterior motives. They don't want their banks to fail," said the U.S. banking official.
One European banking official said King had long been a "visceral opponent" of allowing mortgage-backed securities into the liquidity buffer. Such bonds lay at the heart of the U.S. subprime collapse that provoked the 2007-09 financial crisis.
At least 60 percent of the Basel liquidity buffer has to be in government debt but the euro zone crisis shattered the assumption that this was always low-risk as Irish and Greek debt became difficult to trade.
Regulators also began to accept that more flexibility was needed as some relatively debt-free countries such as Norway, Denmark and Australia didn't have a large enough pool of local government bonds to tap.
France did not get all its own way. The committee refused to give blanket permission for any asset that central banks accept to be included in a lender's liquidity buffer. There was also no scaling back on the rule that 60 percent of the buffer had to be in sovereign debt.
When it came to influencing the Basel regulations, there was little of the traditional "wining and dining", the sources said. Instead most of the lobbying was done via technical presentations and acronym-heavy email exchanges.
"It can happen that people meet over coffee or lunch but that's certainly not the rule," said one German lobbyist. "It depends on the subject, but the discussions tend to be more formal. You don't just drop by for a chat."