UPDATE 1-Peugeot considers Santander deal to loosen state grip
* Peugeot and Santander discuss finance venture - sources
* EU decision on Banque PSA rescue expected within weeks
* Santander deal could replace Peugeot state guarantee
By Sophie Sassard and Matthieu Protard
LONDON/PARIS, July 22 (Reuters) - PSA Peugeot Citroen and Banco Santander are discussing a consumer finance venture that could give the troubled carmaker more freedom from state interference and the Spanish bank a bigger presence in France, people with knowledge of the matter said.
Peugeot is in talks over a partial sale of Banque PSA Finance that would allow the car loans arm to operate without its 7 billion euro ($9.2 billion) state guarantee and strings attached, said one of the sources, who asked not to be identified because the discussions were confidential.
Santander and Peugeot both declined to comment.
Peugeot's guarantee, issued last year, brought limits on executive pay and job cuts, a government-appointed board director and a European Union state aid probe that is still under way.
According to the Wall Street Journal, which first reported the talks, one scenario under consideration would see Santander take 50 percent of Banque PSA Finance or a larger joint venture.
Peugeot, the carmaker worst hit by Europe's five-year auto market slump, made a loss of 5 billion euros last year and is still burning through more than 100 million euros each month.
People with direct knowledge of the company's finances agree with many analysts that, to recover from the crisis, Peugeot will need fresh capital and a deeper alliance with General Motors or another industrial partner.
The founding Peugeot family has offered to give up control as part of a closer tie-up with 7 percent shareholder GM following inconclusive talks with Chinese partner Dongfeng , sources told Reuters last month.
Santander, already Peugeot's financing partner in Latin America, would take on most of the loan refinancing for the jointly held operation under the deal being discussed, one source said.
"As a consequence, it would also free PSA from government interference, which could potentially help negotiations with GM," the person said.
French government officials did not return calls seeking comment.
Peugeot was forced to negotiate last year's debt rescue after a series of credit downgrades hit its borrowing costs.
The government set up a Peugeot oversight committee and appointed former EADS chief executive Louis Gallois to represent French interests on the board.
Peugeot, which is cutting 11,200 jobs over two years, also agreed to soften its restructuring measures and refrain from paying dividends to shareholders or stock options to executives.
The European Commission is expected to reach a decision within weeks on the legality of the state-backed bailout and any remedies needed to minimize the distortion of competition.
Peugeot is confident about the EU review, a company spokesman said, declining to discuss talks with Santander. "We don't comment on rumours or speculation," he said.
Santander is pushing an expansion of its consumer finance business, which includes high-margin auto-loan financing through dealerships.
The division operates in 12 European countries including Germany, Britain, Italy and Spain but is absent from France, the region's third-biggest auto market.
Santander group already has corporate and investment banking operations in France.