UPDATE 1-German cabinet backs Landesbank "bad bank"

(Adds finance ministry statement, government spokesman)

BERLIN, June 10 (Reuters) - Germany's cabinet on Wednesday backed a "bad bank" plan for the Landesbank sector that would allow the publicly owned lenders to offload toxic assets and problematic business activities, the Finance Ministry said.

Under a deal brokered by Finance Minister Peer Steinbrueck last week, German state leaders agreed to consolidate the Landesbank sector by the end of 2010 in return for the federal government's help in the form of the "bad bank" model.

The plan, which must be approved by parliament, would create a federal institute for financial market stabilisation (FMSA) into which Landesbanks could offload non-strategic business operations.

"With this, the government particularly wants to support the necessary consolidation of the Landesbanks," the Finance Ministry said in a statement.

The financial crisis has given Berlin more leverage to press its case for consolidation in the Landesbank sector -- a push it has made for years but which has met resistance from German states, whose leaders want to avoid job losses in their regions.

Regional leaders have also long protected Landesbanks as trophies that gave them influence over businesses.

At least four of the seven Landesbanks -- HSH Nordbank [HSH.UL], BayernLB [BAYLB.UL], LBBW [LBBW.UL], and WestLB [WDLG.UL] -- need to offload billions of euros of risky assets.

"The government expects that in two to three years there will be fewer than seven Landesbanks and a completley changed Landesbank structure," government spokesman Thomas Steg told a regular news conference.

The Landesbanks' owners -- generally states and savings banks -- would carry responsibility for any risks arising from toxic assets moved into the "bad bank".

"For the government, it has always been clear that the responsibility (for risks) is with the owners. Our position on this won't change," Steg said.

Once used as a source of cheap finance by the country's savings banks, the Landesbanks suffered a blow in 2005 when Brussels effectively stripped them of state guarantees that had granted them top-notch credit ratings.

The bad bank plan aimed at Landesbanks complements an existing model tailored towards commercial banks.

Banks across Germany are weighed down by billions of euros in toxic assets, hindering lending and aggravating the severest recession in Europe's largest economy since World War Two. (Reporting by Andreas Moeser, writing by Paul Carrel; Editing by David Cowell)