European bank shares rose Friday on hopes that new international capital rules for lenders would be applied with a lighter touch in the European Union as Germany and France demand more leeway.

Berlin and Paris have pushed for more flexible treatment of some types of bank capital including controversial hybrid bonds in a debate over the rules that are designed to make banks more stable, an EU source said Friday.

Germany wants lighter treatment of some hybrids, bonds that combine characteristics of debt and equity, which have been used in the past to bolster banks' capital cushions.

Both countries, home to Europe's top insurers and where there are close ties between insurers and banks, are also keen to protect the status of stakes banks hold in insurers when calculating their capital.

Friday, the Financial Times said the European Commission had proposed that banks be allowed to side-step part of an international accord on bank capital, seen as a sign that Berlin and Paris had pushed through their demands.

The newspaper said rules the EU executive had drafted would allow European banks to count more of the capital in their insurance subsidiaries than had been agreed globally as well as giving bank more leeway on hybrids.

One German banker told Reuters that the country was winning the argument for flexibility in the treatment of a unique form of German hybrid capital, known as silent participations, relied on by regional banks known as landesbanks to support their balance sheets.

Europe's banking index was up roughly 1 percent in early morning trade, outperforming a 0.6 percent gain in the benchmark FTSE Eurofirst 300 index.

French banks Credit Agricole was among the top gainers, up about 4 percent. One analyst estimated that lighter capital rules could save the bank 4 billion euros.

Banks with big insurance arms, such as British lender Lloyds and France's Societe Generale and BNP Paribas, also rose. Lloyds, SocGen and BNP all gained by about 2 percent.

ROW LOOMS

The law, however, is far from being finalized.

All EU countries, including Britain, which has demanded tougher rules, have first to approve the proposal. The European Parliament, which has campaigned for tighter regulation, will also have a chance to beef it up.

British Finance Minister George Osborne recently co-wrote a letter to Michel Barnier, the European official in charge of financial reform, demanding there be no retreat from the capital regime agreed internationally -- Basel III.

The UK fully supports the implementation of Basel III as agreed by the G20 leaders without any watering down, a British diplomat told Reuters.

Barnier pledged Friday to fully implement the rules and that there would be no loopholes.

I will not be swayed by various pressures, he said.

Basel III is a set of minimum capital and liquidity requirements for banks, endorsed by world leaders last November and set to be phased in over six years from 2013.

A regulatory source said the EU was divided, with some states worried the global accord will be weakened when it gets introduced into the bloc's law.

The Basel Committee has pledged to monitor closely how the new rules are applied but it has no power to sanction those who ignore the standard. It had no comment Friday.

Consistent application is something very high on the agenda, said the source. There will be considerable transparency over how the rules are applied and laggards would have to explain themselves.

Under the new Basel rules, banks will be allowed to use stakes in other financial institutions such as insurers for up to 10 percent of its capital cushion.

The global rules, which are being phased in over six years from 2013, give an even more generous timeframe -- until 2023 -- to phase out the use of hybrid debt.

(Reporting by Karolina Tagaris and Sudip Kar-Gupta in London, Arno Schuetze and Jonathan Gould in Frankfurt; Additional reporting by Juliette Rouillon and Jon Hopkins; Editing by Jon Loades-Carter and Jane Merriman)