By Manya Saini

(Reuters) -Shares of U.S. banks regained some footing on Tuesday, with one of the top regional banking indexes hitting its highest in nearly seven weeks, as investors shrugged off reports of tighter capital requirements for banks.

The tenuous relief rally comes at a difficult time for a banking sector that has been grappling with worries around deposit flight, rising interest rates and exposure to commercial real estate since March.

The KBW Regional Banking Index extended gains to hit its highest since mid-April. It was last up 5.2%. The S&P 500 Banks index advanced 1.7%. In comparison, the benchmark S&P 500 index was last up marginally.

Wall Street’s main indexes also rose on Tuesday on the back of a banks-led rally in economically sensitive sectors. [.N]

Big banks such as Wells Fargo, Goldman Sachs, Morgan Stanley, Citigroup and Bank of America rose between 1.6% and 2.8%.

Regional lenders were also higher, with PacWest Bancorp, Western Alliance, Zions Bancorp, Comerica, Truist Financial and KeyCorp rising between 4.4% and 7%.

Short-sellers will see a combined $145.7 million in paper losses from the gains in shares of the six regional lenders on Tuesday, data from analytics firm Ortex showed.

“Our baseline does not anticipate a further intensification of banking stresses,” analysts at Deutsche Bank wrote in a client note on Monday.

Fed fund futures indicate traders have priced in a near 80% chance the U.S. central bank will hold interest rates in the 5%-5.25% range, according to CMEGroup’s Fedwatch tool.

“A pause by the Federal Reserve puts a pause on what’s been negatively affecting the regional banks,” said Chuck Carlson, CEO at Horizon Investment Services.

“It might relieve pressure on them having to aggressively pay up to hold onto their deposits.

Still, the volatility in regional lenders has underscored ongoing investor uncertainty over the health of the sector, with the KBW Regional Banking index losing 20.6% this year.

U.S. banks could also face capital hikes of as much as 20% under new rules being prepared by the country’s regulators, Reuters reported on Monday, citing a person familiar with the matter.

Bank stocks fell on Monday, with some investors worried a flood of Treasury bill issuance following the raising of the U.S. debt ceiling would drain liquidity from lenders.

Some analysts have warned this flurry of new bills could drain bank reserves.

(Reporting by Manya Saini in Bengaluru, additional reporting by Stephen Culp in New York; Editing by Shounak Dasgupta and Krishna Chandra Eluri)

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