ECB sees underpriced geopolitical risks, warns against easing bank rules ?

FRANKFURT, March 18 (Reuters) - Financial markets are underpricing geopolitical risks, increasing the potential for sudden sell-offs, European Central Bank supervisor Claudia Buch said on Wednesday, as she warned against easing bank regulations.?

The U.S. has been loosening bank rules for the past year, putting pressure on regulators elsewhere as their lenders could face an uneven playing field if they did not follow suit.

"These guardrails need to be maintained as geopolitical tensions rise," Buch said in the ECB's annual supervision report. "Fragmentation or any weakening of standards could undermine banks' ability to withstand adverse developments."

Bank shares have sold off since the start of the U.S. and Israeli war on Iran but market moves have been orderly, much like over the past year when tariffs and wars raised uncertainty.

Lenders are properly capitalised and have all the necessary buffers, but risks remain high, Buch argued.

"This uncertainty is not adequately reflected in market-based indicators of financial stress, which could lead to an abrupt repricing of risk," she said.

She argued that shocks could materialise unexpectedly and spread quickly given geopolitical tensions, stretched valuations in some market segments, growing interconnections with non-bank financial firms and the risk of sudden shifts in market sentiment.

The ECB has made strengthening lenders' resilience to geopolitical risks a key priority for this year and will stress test the largest banks in the coming months.

(Reporting by Balazs Koranyi, editing by Andrei Khalip)