(Adds quotes, background) SYDNEY, July 29 (Reuters) -...

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SYDNEY, July 29 (Reuters) - Australia's financial watchdog on Wednesday withdrew a request for banks and insurers to freeze dividends due to the novel coronavirus, but ordered them to pay less than half their profit to shareholders for the rest of the year.

The Australian Prudential Regulation Authority (APRA) asked the financial sector to defer paying dividends in April as government agencies raced to protect the economy from roiling financial markets and shutdowns of travel and most community activity.

The change to the directive allows some of the country's biggest companies to resume paying out shareholders while ensuring they keep a larger than usual buffer against further financial shocks, the regulator said.

"Although the environment remains one of heightened risk, we now have a stronger sense of how Australia's economy and financial institutions are being impacted by COVID-19," APRA Chair Wayne Byres said in a statement.

"Banks and insurers do not need to continue to defer capital distributions, provided they moderate payments to sustainable levels based on robust stress testing, and continue to prioritise supporting their customers and the economy."

The change comes soon before most Australian companies report annual results, when they typically declare final dividends.

APRA's guidance was not mandatory but all three of the country's four major banks that were affected by the request - Westpac Banking Corp (WBC) , Australia and New Zealand Banking Group Ltd (ANZ) , and National Australia Bank Ltd (NAB) - deferred or cut dividend payments worth over A$7 billion.

Commonwealth Bank of Australia (CBA) , the biggest lender, gave its last dividend annoucement before APRA's initial directive. It is due to post its full-year results on Aug. 12.