UPDATE 4-Japan may inject funds into regional banks -paper

(Updates share prices)

By David Dolan

TOKYO, Jan 7 (Reuters) - Japan's government may inject money into scores of regional banks, a newspaper said on Wednesday, sending shares of small lenders such as Tokyo Tomin Bank sharply higher, even as the government dismissed the report.

The government could give 40 or more local banks handouts to boost their capital and make them more willing to lend out money amid the credit crunch, the Mainichi newspaper said.

But an official at the regulatory Financial Services Agency said Tokyo was not currently considering a broad injection of public funds. The government has recently eased rules to encourage local banks to apply for public money.

Japanese banks, especially the small lenders that depend on fragile, regional economies, have become increasingly wary about lending as the global downturn hits home.

Saddled with rising bad loan costs and a dwindling customer base, local banks have also been hit by heavy exposure to languishing domestic stocks.

"Even though there are obviously a few problems, they don't pose a major systemic threat," Jason Rogers, credit analyst at Barclays Capital, said of Japan's regional banks.

Analysts have long said that rural Japan is overbanked -- many prefectures are home to several local lenders -- and that broad consolidation of regional banks in necessary.

However, Rogers said the government was unlikely to let local banks fail.

"They dont want to start inflicting losses on depositors. I don't think we want to see a liquidation of the banks, what we might see are some tough measures. Some more radical restructuring of the regional banking sector is something the authorities should be considering."

BOOSTING CAPITAL

Unlike the regional banks, Japan's large lenders such as Mitsubishi UFJ Financial Group have already bolstered their capital by issuing new shares and preferred securities.

The government aims to boost the capital adequacy ratio of the regional banks to around 8 percent from as low as 4 percent, and plans to inject the funds by March, the Mainichi said.

The FSA estimates that the plan is feasible within an existing public fund framework of about 2 trillion yen ($21.4 billion) which would easily allow an injection of 10 billion yen into each bank, the paper said.

Shares of many small banks jumped in Tokyo trade on hopes they may benefit from a handout. Tokyo Tomin Bank rose 5.7 percent to 1,460 yen by early afternoon, while Kagawa Bank gained 4.2 percent to 527 yen.

Bank of Yokohama, Japan's largest local lender, gained 3.1 percent to 529 yen. Midsize lender Aozora Bank, which does business with many regional banks, rose 1.2 percent to 82 yen.

Tokyo's index of bank stocks was up 1.0 percent as of 0433 GMT, roughly in line with the rise in the broad TOPIX index. Traders said a separate Nikkei business daily report that the government aimed to scrap capital gains taxes for foreigners investing in Japanese companies through funds may also be lifting shares.

Banks in Asia have largely avoided the massive credit losses that drove some of their U.S. peers out of business, but a growing number are being forced to sell shares and bonds to raise funds as the global economy weakens, leading to more bad loans.

Some economists think the downturn will last well into next year, putting more pressure on businesses, the property market and other assets and forcing banks to set aside more money for an expected surge in loan defaults. (Additional reporting by Reiji Murai, Taiga Uranaka, Yumiko Nishitani, Tetsushi Kajimoto; Editing by Hugh Lawson)