(Corrects 20th paragraph to show that Ana Botin was appointed in September 2014)
By Pamela Barbaglia, Sinead Cruise and Anjuli Davies
LONDON, Jan 20 (Reuters) - Banco Santander's renewed interest in buying UK lender Williams & Glyn IPO-WILL.L has stoked concerns it may need to step up asset sales and even raise cash to strike a deal some investors say it can ill afford.
A move for Williams & Glyn, held by the Royal Bank of Scotland, would help the euro zone's biggest lender poach valuable market share in Britain's competitive banking sector, but could cost as much as 2 billion pounds ($2.8 bln).
Santander, which already controls former UK building societies Abbey and Alliance & Leicester, is keen to expand in Britain to offset weakness in its domestic market, Spain, where analysts expect sharp rises in bad loans and volatile credit demand.
Several sources familiar with the bank's strategy say it is reviewing options to boost its financial firepower as it weighs a bid for Williams & Glyn, so it can bolster its balance sheet and avoid upsetting shareholders already spooked by its capital position relative to European rivals.
The Spanish bank is working with UBS on a new bid for Williams & Glyn after previous talks with RBS fell apart in 2012 amid concerns about the lender's standalone technology platform, three sources with direct knowledge of the matter said.
"The fact they're considering a bid for Williams & Glyn is, on paper, disconcerting," said Xavier VanHove, a partner and fund manager at THS Partners, an investor in Santander.
"If it is part of an empire-building campaign, then we would have serious issues with it."
A spokesman for Santander UK would not confirm that a bid for Williams & Glyn is being prepared.
"As (Chairwoman) Ana (Botin) said at the recent Santander Investor day in September 2015, we will continue to analyse opportunities in our core 10 markets where they add value and benefit to our customers and shareholders," the spokesman told Reuters. "That said, we do not comment on rumours or market speculation."
A deal would give Santander up to 10 percent of the UK market, which has already captured the interest of the bank's biggest Spanish rivals, Banco Sabadell and BBVA .
Williams & Glyn has more than 300 branches in Britain and Santander will have to outbid the likes of Virgin Money and a handful of private equity investors to land its prize, the three sources said, speaking on condition of anonymity.
Sources close to Santander's management said the bank started reviewing options to raise up to 5 billion euros ($5.5 bln) at a subsidiary level, rather than at a holding level, in late 2015.
One plan, for example, is to set up a subsidiary in South America and use it as a vehicle to launch a rights issue, one of the sources said, adding the project was last discussed in December but has yet to receive approval.
"Senior management is under increasing pressure," said the source who held recent meetings with the Spanish bank.
"There is a clear recognition that they need to raise cash, but how they'll do it remains unclear."
A Madrid-based spokeswoman for Santander said the bank is comfortable with its capital levels and there is no concern about the bank being stretched on capital.
Botin said in September that the Spanish lender would generate capital organically to be above 11 percent of common equity Tier 1 (CET1) by 2018 or before.
Botin also said Santander would be "very disciplined in M&A [mergers and acquisitions]."
Santander raised 7.5 billion euros in January 2015 in one of Europe's biggest-ever quick-fire share sales.
The cash call was the first major move by Botin to shake up the bank since taking over from her late father Emilio in September 2014.
Since then Santander has been reluctant to tap shareholders for cash again, but with the global economy stuttering and many of the bank's key markets vulnerable to downturns in the short to medium term, sources said Botin may be left with little choice.
Reflecting the bearish outlook on the bank, Santander's five-year credit default swaps are trading at 165 basis points, currently higher than any other major European lender, Thomson Reuters Datastream data shows. That means it now costs investors 165,000 euros per year to cover 10 million euros of Santander's corporate debt against default.
Botin, 55, who represents the fourth generation of her family to run the bank, also cut its dividend policy to strengthen the bank's capital buffers and pursue growth in Britain and the United States.
She is now expected to review the banks' network of overseas subsidiaries to avoid, or at least delay, another rights issue, the sources said.
Botin could pursue a sale or listing of Santander's North American division, sources said, adding it was one of three foreign banks to have its capital plans rejected by the U.S. Federal Reserve in 2014.
The Boston-based division owns Santander Bank N.A., which has branches in the Northeast, and around 69 percent of Santander Consumer USA, which sells consumer and auto loans.
One source said Santander's U.S. business does not have many synergies with its European business, making it an obvious disposal candidate.
"The flow of business between their U.S. and European divisions is not enough to maintain a presence across the pond," he said.
Botin, however, said in September that listing subsidiaries was no longer a priority.
Another option could be to sell various non-core assets in Europe, the sources said, including a controlling stake in Spanish real estate firm Metrovacesa.
A source familiar with the situation said there has been interest in Metrovacesa.
In September, Santander said it was in the process of spinning off its 16.2 billion euro real estate business in Spain into a standalone unit. Its Metrovacesa operations were then valued at 5.1 billion euros.
It also said it planned to reduce risk weighted assets (RWA) by 30 billion euros or around 4 percent in the next three years. ($1 = 0.9181 euros) ($1 = 0.7047 pounds)
Additional reporting by Jesus Aguado in Madrid and Alex Smith in Davos; Editing by Susan Fenton