By Tommy Reggiori Wilkes

LONDON (Reuters) -Shares in UBS dropped 7% on Tuesday as analysts voiced concern about the impact of new government proposals to force the Swiss lender to hold $26 billion in extra capital, including on the bank's plans to return cash to shareholders.

UBS' stock had risen after the government on Friday announced its proposals to prevent another Credit Suisse-style meltdown.

But on Tuesday the shares reversed those gains and fell sharply. By 1235 GMT they were down 6.6% at 26 francs, set for their biggest one-day drop in two months. Swiss markets were closed on Monday.

The bank's capital returns to investors for 2026 and beyond remain uncertain, Deutsche Bank analysts said in a note, even as UBS on Friday reaffirmed its intention to return $3 billion in capital this year.

Traders also cited worries about the impact on UBS's buyback plans as a reason for the share price fall.

JP Morgan analysts said they had already lowered their buyback estimates to $3.5 billion from $6 billion for next year, and to $4 billion from $8 billion in 2027, because the Swiss proposals were the "worse-case scenario".

"We are thus already pricing the worst case scenario, leaving upside from any improvement in the final rules. We think with the share price reaction today, UBS shares have priced these proposals more than enough," they said on Tuesday.

Others disagreed about the likely impact on buybacks.

UBS should be able to manage the extra capital demands without affecting future buybacks and dividends, Citi analysts said. But they were worried about the rules being amended as they move through a consultation and legislative process, and about UBS’ consensus earnings momentum, "which continues to be weaker than peers on ongoing NII (net interest income) softness."

Uncertainty over the capital requirements have clobbered UBS shares. So far this year the stock has lost nearly 9%, against a 30% rally in a European banking share index.

While the government proposals confirmed some of UBS' worst fears, the bank will have six to eight years to prepare for them becoming law, a time in which the rules may change.

UBS executives say the additional capital burden will put the Zurich-based bank at a disadvantage to rivals and on Friday called the requirements "extreme" and "neither proportionate nor internationally aligned."

Switzerland's Finance Minister Karin Keller-Sutter said the measures were crucial for financial stability and would protect taxpayers.

(Additional reporting by Danilo Masoni in Milan and Siddarth S in Bengaluru; Editing by Amanda Cooper and Hugh Lawson)