UPDATE 3-Obama to bolster U.S. small bank capital, lending

* Obama offers funding to aid small banks

* New bank capital aimed to boost small business lending

* Proposes bigger Small Business Administration loans (Recasts with Obama comments, industry reaction)

By David Lawder

WASHINGTON, Oct 21 (Reuters) - President Barack Obama on Wednesday pledged to boost lending to small businesses in the hopes of spurring job growth by offering low-cost, taxpayer capital to community banks.

Under the plan, the Treasury Department would provide funds from the government's $700 billion financial rescue program to small community banks. Obama said they would have to pay the government no more than a 3 percent annual dividend, not the 5 percent that banks were previously charged.

Obama also said he was seeking legislation to substantially raise the maximum of different Small Business Administration loans programs. For a Factbox on the plan, click on [ID:nN21498243].

"There is still too little credit flowing to our small businesses," Obama said at the Landover, Maryland, warehouse of a small records storage company. "There are still too many entrepreneurs who can't get the loan they need to open their doors and start hiring."

Obama said he was ready to shift the focus of the Troubled Asset Relief Program, from large, Wall Street banks to the more than 7,500 small and community banks that do a bigger percentage of their lending with small businesses.

"The major banks that were in critical condition a year ago need no new assistance from the government, and so we are winding down that portion of the TARP program," Obama said. "But to spur lending to small businesses, it's essential that we make more credit available to the smaller banks and community financial institutions that these businesses depend on."

Obama's announcement comes a day after U.S. Treasury Secretary Timothy Geithner told the Reuters Washington Summit that he was ready to shift the TARP to target key areas where credit markets still needed repairs -- namely small business and housing.

U.S. Commerce Secretary Gary Locke told the Reuters summit on Wednesday that increased lending to small business could have a "huge ripple effect" in terms of job creation, given that smaller firms have created 65 percent of all new U.S. jobs over the past 15 years.

"This is what the American public wants and that's what small business owners want," Locke told the Reuters Washington Summit. "I mean let's not just bail out the banks, but let's make sure that when we help the banks that it benefits taxpayers and small business owners."

With the U.S. unemployment rate nearing 10 percent, Obama is under pressure to boost job creation ahead of midterm congressional elections next year.

Public approval of his handling of the economy is at about 50 percent, up slightly from September, but many people are pressing for new measures to stimulate the economy, saying Obama's previous efforts have fallen short.

The new program for community banks comes at a time when policymakers are increasingly concerned about rising defaults on commercial real estate loans, an area where smaller banks have high concentrations of their assets.

Small business and banking groups applauded the announcement, saying it was a step toward getting the broader "Main Street" economy moving again.

"We're optimistic that the administration finally recognizes the scale and scope for small community banks as a delivery channel for increasing small business lending," said Paul Merski, chief economist for the Independent Community Bankers of America, a Washington trade group.

The previous capital injection program for banks was too expensive for many smaller banks and lower capital costs will help, Merski said, adding that many hurdles to robust credit still remain.

"The biggest problem is the economy itself. Many banks say that there is not quality loan demand out there and the businesses seeking loans are too risky to lend to." he added.

AMOUNT OF CAPITAL STILL UNCLEAR

Obama administration officials left unclear the amount of money from the financial rescue fund that might be used to increase capital for small businesses.

The Treasury will consult with community bankers and small businesses in coming weeks to gauge the demand for capital and decide how much taxpayer money will be put up.

An administration official said the total would be within existing rescue fund resources and would not depend on larger banks repaying capital to the Treasury. According to the bailout fund's special inspector general, about $138 billion of the original $700 billion is currently unallocated.

Banks that apply for the new program will be required to submit more specific plans on how the government capital will allow them to increase lending to small businesses. They also will have to file quarterly reports on their activities -- requirements that go beyond those of previous rescue programs.

Obama said he would seek legislation to more than double the size limit for the Small Business Administration's 7(a) loan guarantee program to $5 million from $2 million.

Other loan limits would also be raised under the plan, including increasing the maximum "micro-loan" for certain small business start-ups to $50,000 from $35,000. (Additional reporting by Tim Ahmann and Glenn Somerville; Editing by Kenneth Barry)