By Lindsay Dunsmuir

WASHINGTON (Reuters) - Major insurers American International Group Inc <AIG.N> and Prudential Financial Inc <PRU.N> would be required to hold enough capital to head off risks to the U.S. financial system as part of a regulatory shakeup of the insurance industry proposed by the Federal Reserve on Friday.

The U.S. central bank gained regulatory authority over the two systemically important insurance companies and 12 insurance firms that own banks as a result of the 2010 Dodd-Frank reform law designed to strengthen U.S. oversight of Wall Street.

Under the proposals, insurance firms that own banks will also face a new set of capital standards. Details on capital requirements for the two types of insurers overseen by the Fed have yet to be determined.

The proposals, which have been five years in the making, seek to force the companies to have enough capital on hand to ward off excessive borrowing or insolvency and prevent a repeat of the 2008 financial crisis.

AIG and Prudential have been deemed "too big to fail" because of the outsized threat they pose to financial stability.

For them, the Fed proposes a consolidated approach with firms' assets and liabilities categorized into segments based on potential risk with those that pose a higher threat requiring more capital against them.

Under a separate proposal, they would also have to comply with new corporate governance and risk-management standards including undergoing regular liquidity stress testing, providing comprehensive cash flow projections and developing contingency funding plans should there be a liquidity crunch.

They would also need to maintain a 90-day liquidity cash buffer. Both companies' stocks were little changed following the release of the proposals. AIG did not immediately respond to a request for comment.

A Prudential spokesman said in a statement: "We view this as a positive step forward that recognizes the underlying economics of our businesses."

As insurance companies that own banks are generally less complex and have fewer international activities, the Fed plans a "building block" approach in which they would aggregate the capital across a firm's different units to calculate a single requirement.

The proposed two-tier framework for the separate types of firms "reflects the different risks they pose to the safety and soundness of depository institutions and to the financial system more generally," Fed Governor Daniel Tarullo said in a statement.

He added that the central bank had adopted such an approach to avoid unnecessary compliance costs on those who pose the least risk.

The Fed currently oversees roughly one quarter of the $8 trillion U.S. insurance industry.

MetLife Inc <MET.N>, the largest U.S. life insurer, was previously categorized as systemically important, but a federal judge struck down that designation in March. The U.S. government has appealed.

There is no currently defined timeline for when the Fed expects the proposals will be finalized, Federal Reserve officials said. The next step in the rulemaking process for both proposals is a period for public comment until Aug. 2.