* Dollar falls vs yen, euro as risk appetite recedes
* U.S. stocks tumble for third day; volatility rises
* Euro still on track for weekly drop versus dollar
* Greek deficit, Chinese tightening still weigh on market (Adds comments, details. Updates prices)
By Vivianne Rodrigues and Michael O'Boyle
NEW YORK, Jan 22 (Reuters) - The dollar fell against the euro and yen on Friday as investors exited risky trades, unnerved by U.S. President Barack Obama's proposals to limit risk-taking by U.S. banks.
The yen, which often benefits when investors grow nervous, touched a five-week high against the dollar and hit a nine-month peak against the euro, while global stock markets slumped for a second day. The euro rebounded from Thursday's near six-month low against the greenback.
Obama's proposals were the latest setback in a market hampered by fiscal concerns in some euro zone economies and by speculation China would take more steps to withdraw liquidity to stem inflation.
"President Obama added a whole new level of uncertainty back into markets," said Tom Fitzpatrick, chief technical strategist at Citigroup in New York. "The euro was headed straight down and now the movement has been reversed. The dollar is being sold and investors also flocked to the yen."
The dollar hit a session low of 89.79 yen <JPY=>, according to Reuters data, and was last at 89.84 yen, down 0.6 percent on the day.
The euro hit a session low against the yen of 126.58 yen before rebounding to 127.01 yen <EURJPY=>, still down 0.3 percent on the day. It also rose 0.3 percent to $1.4139 <EUR=> after nearing a six-month low of $1.4028 a day ago.
The euro has been under steady pressure this year as investors have worried about euro zone member Greece's ability to rein in its fiscal deficit. The currency was down about 1.4 percent against the dollar this week.
French President Nicolas Sarkozy repeated his demand for more order in currency markets, saying it was unacceptable that the euro was bearing the brunt of foreign exchange imbalances. For details see [ID:nLDE60L221].
Investors, uncertain about the likely impact of Obama's bank proposals, sought to square out dollar positions going into the weekend after the U.S. currency's recent strong gains, analysts said.
The proposals, which require congressional approval, would prevent banks or financial institutions that own banks from investing in, owning or sponsoring a hedge fund or private equity fund. [ID:nN21658127]
"Although the impact of Obama's proposed banking regulation changes is clear enough on equities, currency markets seem to see the implications as ambiguous," said Adam Cole, global head of currency strategy at RBC Capital Markets in London.
Stocks tumbled on Thursday and Friday, their biggest decline since October following Obama's announcement of tough restrictions that would squeeze banks' profits.
U.S. stock indices fell as the VIX index <.VIX>, viewed as gauge of investor apprehension, jumped over 20 percent.
"The market is still focused on the impact of the proposed banking legislation," said Kathy Lien, director of currency research at GFT in New York. "Whenever there is political uncertainty, traders always sell first and ask questions later." (Additional reporting by Steven C. Johnson in New York and Tamawa Desai in London; Editing by James Dalgleish)