A brief run on Myanmar's largest bank last week highlights what economists and academics say is the urgent need to reform a fragile banking system, that is prone to rumors and speculation, as it rapidly expands.

The problem is compounded at banks whose owners remain targeted by U.S. sanctions for links to the former military junta. Tainted by sanctions, they could struggle to project a new, clean image in reform-era Myanmar and remain especially vulnerable to speculation and rumors, the analysts said.

In the biggest test since Myanmar's fledgling banking system started a major overhaul, some 9 billion kyat ($10.5 million) was withdrawn on Friday from Kanbawza Bank Ltd on unfounded rumors that police had intercepted a Kanbawza truck loaded with contraband and arrested the bank's chairman, Aung Ko Win.

Kanbawza and the central bank denied the rumors and assured panicky depositors the bank's 80 branches had enough capital to withstand the run at its two biggest cities, Yangon and Mandalay. But it took days to restore confidence.

"I'm sure we can survive and in an emergency, we can borrow from the central bank with the bonds we have bought from them," the bank's vice-chairman, Than Lwin, told Reuters.

A third of deposits were tied up in bonds, he said, and each branch had enough cash to handle withdrawals. The bank, which has 100 billion kyat in capital, said the panic withdrawals had stopped as of Monday.

The run on the Kanbawza bank revived memories of two banks that collapsed in 2003, during the military's economically disastrous 1962-2011 rule and the dominance of the sector by blacklisted cronies. Ten banks are now owned by businessmen with ties to the former military junta.

Kanbawza bank is part of Aung Ko Win's KBZ Group, which owns two airlines and lucrative concessions for mining of rubies, jade and sapphires, which he secured due to his friendship with the junta's former second-in-command, General Maung Aye.

'LONG WAY TO GO'

Jared Bissinger, an expert on Myanmar's economy at Australia's Macquarie University, said that after years without reliable information or an independent media, rumors carried great weight in Myanmar, exacerbated this time by a "persistent lack of public trust" in the banking sector.

"The banks are better regulated and more well-capitalized now than they were 10 years ago... but this will re-emphasize to everyone the importance of doing your homework about potential business partners in Myanmar," he said. "It's absolutely a reminder that Myanmar still has a long way to go."

The source of the Kanbawza rumors remains a mystery and the central bank insisted it was fully behind all of Myanmar's 19 banks, some private, some part state-owned. A Kanbawza insider told Reuters it may have been started by businessmen seeking to push up the local price of gold.

Aung Ko Win on Tuesday described the rumor as an "attack" instigated at home and abroad "with intent to hurt not only the country's economic but also political situation."

Another cause for concern is the lack of insurance for deposits, meaning the run could happen again at any time.

After five decades of brutal junta rule, Myanmar is Asia's second-poorest country, but as it opens up its economy, at stake is influence in Asia's last frontier market.

Myanmar is as large as Britain and France combined, it shares borders with 40 percent of the world's population in India, China, Bangladesh and Thailand and its ports on the Indian Ocean and Andaman Sea sit just north of the Malacca Strait, one of the world's busiest shipping lanes.

New investors in Myanmar will need to rely on the country's existing banks for now. The central bank has indicated most foreign banks will not be allowed to operate for two or three years, but there is no shortage of interest, with lenders like Standard Chartered (STAN.L), Malayan Banking Berhad (Maybank) (MBBM.KL), and Bangkok Bank BBL.BK among more than a dozen that have set up representative offices in Yangon.

Andrew Gilholm, head of Asia Analysis at Control Risks, said the panic over Kanbawza would pose little danger to what was a small and well-supported banking system, but it demonstrated the hurdles ahead in reforming Myanmar's economy.

"The episode is certainly a reminder of the extremely low base from which Myanmar's reform and opening up process is starting ... It's a very complex and very difficult process being undertaken," he said.

"It will take time and there's a pretty high likelihood of many hiccups along the way. Investors have to understand that the low base works both ways: yes, it means great untapped potential, low costs and so on, but it also means uncertainty and a significant risk of economic volatility."

(Reporting by Martin Petty reported in Bangkok; Editing by Jason Szep and Michael Perry)

• A Permanent Economic Emergency