By Will Caiger-Smith

NEW YORK (IFR) - Investors continued to plough cash into US bank stocks and bonds on Thursday as president-elect Donald Trump's transition team vowed to "dismantle" the Dodd-Frank Act.

But market participants cautioned that rolling back post-crisis financial regulation too much could make bank debt riskier.

The S&P 500 Financial Sector index was up 3.78% on Thursday as investors bet on the prospect of looser regulation as well as a steeper yield curve and higher interest rates.

Average high grade bank spreads closed 1bp tighter on Wednesday at 127bp, while financial services were also 1bp tighter at 162bp, according to Bank of America Merrill Lynch.

Investors said bank debt was 3bp-5bp tighter on Thursday.

"Banks are better bid across the board," said a bond trader, adding that the theme of lighter regulation was "under constant discussion" with clients.

Rolling back financial regulation was a feature of Donald Trump's election campaign, although he also advocated breaking up large banks.

In a statement on their website, Donald Trump's transition team promised to "dismantle" Dodd-Frank and replace it with "new policies to encourage economic growth and job creation".

But while that was taken as positive for shareholders, market participants said looser regulation was more of a mixed bag for creditors.

"So much of the story in terms of bank credit performance since the financial crisis has been about increased capital and liquidity requirement, as well as stronger regulatory oversight in general," said James Strecker, a bank analyst at Wells Fargo.

"The further bank bond investors see regulations get pulled back, the more anxious they are likely to be."

Others said it would be difficult for the Trump administration to simply roll back the clock on post-crisis financial reform.

"They are going to find out that it's more complicated than that," said Oliver Ireland, a partner at Morrison Foerster who previously served as associate general counsel to the Fed.

"For example, some provisions of Dodd-Frank require banks to cease certain activities. Removing the prohibition does not immediately take you back to where you were before." 

But even without legislative change, Trump's administration could easily push regulators to soften their supervision of US lenders, said market participants.

"You don't have to roll back Dodd-Frank - you can simply make regulators more accommodating," said a FIG DCM banker.

"That is easy to envisage. If Trump says [to regulators] you have to ease up on the banks or you lose your job."

(Reporting by Will Caiger-Smith; Editing by Shankar Ramakrishnan)