UPDATE 1-German upper house approves bank expropriation law

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BERLIN, April 3 (Reuters) - Germany's Bundesrat upper house of parliament approved a law on Friday that gives the government the power to take control of banks hit by the financial crisis, potentially forcing shareholders to sell their stakes.

The law, agreed mainly to allow the government to take over stricken lender Hypo Real Estate HRXG.DE, permits the state to expropriate shareholders in financially troubled banks under certain circumstances.

As a first step, the German government last weekend agreed to take an 8.7 percent stake in Hypo, which has said it lost 5.375 billion euros ($7.17 billion) before tax in 2008 and expects to stay in the red for at least two more years.

The government is resorting to the law because it has failed to reach a deal to buy a stake in Hypo owned by a group led by U.S. investor J.C. Flowers.

The new rules are an extension of last year's "financial markets stabilisation law" which gave the government powers to seize control of banks whose failure would pose a risk to the stability of the financial system.

Hypo, Germany's highest-profile casualty of the financial crisis, has already been propped up with more than 100 billion euros in guarantees, mostly from the state.

Germany is following Britain, which has already nationalised several of its banks, including Royal Bank of Scotland (RBS.L).

The new law can take effect once Germany's president signs it, a step widely viewed as a formality.

It will compensate shareholders forced to give up their holdings at the average share price calculated over the two weeks prior to nationalisation, or over a shorter period if the price falls rapidly.

German Finance Minister Peer Steinbrueck said earlier this week that no other bank was calling for a rescue takeover in the way Hypo had.

Expropriating the bank's shareholders has fuelled controversy as such a step is linked in the minds of some Germans to crackdowns on private business by the Nazis and government in communist East Germany.

(Writing by Madeline Chambers; editing by John Stonestreet)