UPDATE 2-Yellen told bank CEOs more mergers may be necessary, CNN reports

(Adds market moves, analyst comment, background in paragraphs 5-11)

By Doina Chiacu and David Lawder

WASHINGTON, May 19 (Reuters) - U.S. Treasury Secretary Janet Yellen told bank CEOs on Thursday that more mergers may be necessary after a series of bank failures, CNN reported on Friday, citing two people familiar with the matter.

A Treasury spokesperson declined to comment on the meeting with CEOs of the largest U.S. banks beyond a statement issued afterwards that reaffirmed the strength and soundness of the U.S. banking system.

The meeting with more than two dozen executives convened by the

Bank Policy Institute

came as the banking sector is endeavoring to shake off several weeks of turmoil spurred by the sudden failure of Silicon Valley Bank, which led to regulators seizing two more collapsing institutions and backing uninsured depositors in an effort to tamp down fears of broader contagion.

The Treasury readout did not mention bank mergers, but CNN quoted sources as saying that consolidation was discussed.

Yellen told Reuters

in an interview in Japan last week that pressures on U.S. regional bank earnings may lead to more concentration in the sector and regulators will likely be open to such mergers.

But the report that she gave a similar message directly to bank CEOs, alongside news that talks over the U.S. debt ceiling were at an impasse, had a significant impact on markets on Friday.

"That's why the market took an initial knee-jerk move," said Michael James, managing director of institutional equity trading at Wedbush Securities.

Two-year Treasury yields initially dropped by some 11 basis points on Friday after the report, while benchmark 10-year yields fell by about five basis points.

Shares of regional banks also fell, with the KBW Regional Banking Index down 2.8% and shares of PacWest Bancorp, Zions Bancorp, Western Alliance Bancorp, KeyCorp and Comerica Inc down between 1.8% and 4%.

Other factors weighing on shares included news that Republicans in the U.S. House of Representatives and President Joe Biden's administration had

paused talks

on raising the $31.3 trillion debt ceiling. The U.S. government may default on some debts as early as June 1 unless Congress votes to lift the debt ceiling.

Federal Reserve Chair Jerome Powell also hinted on Friday at a potential pause in rate hikes

amid more balanced risks in the economy. (Reporting by Doina Chiacu and David Lawder; additional reporting by Sinead Carew in New York; Editing by Caitlin Webber and Paul Simao)