* Govt considers levy on banks for protecting deposits
* Big Four bank shares fall as much as 3 pct before trimming losses
* Budget update due on Friday, ahead of looming elections
* Cigarette makers also hit with new taxes (Recasts lead with new sourcing, updates with new reported figures, Greens comment)
CANBERRA, Aug 1 Australia's Treasurer Chris Bowen confirmed on Thursday he was in discussion with banks about a possible new levy to protect customer deposits as the government seeks new revenue to shore up its budget.
Initial reports of the levy sent shares in Australia's major banks down.
Bowen is expected to update Australia's budget forecasts on Friday, ahead of national elections which could be called at any time, and has said he is committed to returning a surplus budget by 2016-17 despite falling revenues.
Citing unidentified sources, the Australian Financial Review said the proposed levy is between 0.05 percent and 0.1 percent on protected deposits, with the level set at A$100,000 ($89,700). The paper had initially said the levy was between 0.5 percent to 1.0 percent.
Presently, the government guarantees bank deposits up to A$250,000 without charging the banks.
The levy would provide insurance in case future bailouts were needed, the paper said, adding it was estimated to raise less than A$1 billion over four years.
Shares in Australia's Big Four banks - Australia and New Zealand Banking Group Ltd, Commonwealth Bank of Australia, National Australia Bank Ltd and Westpac Banking Corp - fell by around 2 percent following the initial report.
Bowen said he had held talks with banks about how to better protect deposits in the unlikely event of a bank failure, but he stopped short of confirming any new charge.
"The IMF has expressed the view for some time that there is a gap in Australia's public policy when it comes to provisioning for any bank or deposit-taking institution's failure. Our financial regulators have expressed the same strong views," Bowen told Australian radio.
"I've been consulting with banks, and credit unions and others about how we tackle that issue, how we make sure there is money set aside in the unfortunate and very unlikely event that a deposit taking institution in Australia comes into difficulty."
Also on Thursday, Bowen said the government would impose a 12.5 percent increase in tobacco taxes per year for the next four years, to raise an extra A$5.3 billion, over the period.
The Financial Review said the new bank levy was recommended by Australia's Council of Financial Regulators, which includes the Reserve Bank of Australia, the Australian Prudential Regulation Authority, the Australian Securities and Investments Commission, and the Treasury Department.
Australian banks are among the most stable and profitable in the world, and analysts said they expect banks and bank customers to absorb the costs of any new levy.
"Fundamentally, Australian deposits are protected because the structure of our banks are such that deposits effectively are the last in terms of hierarchy, the last to be touched," Nomura banking analyst Victor German said.
"I don't really see strong justification for it.
"The question will ultimately be to what extent pricing will be impacted. Will banks just absorb additional cost, or they pass on some of the cost to the consumer? I think there will be both if this is to be implemented."
The Australian Greens, who hold the balance of power in parliament's upper house Senate, welcomed the new levy, but said the government needed to make sure the costs were not passed on to bank customers.
($1 = 1.1143 Australian dollars) (Reporting by James Grubel; Additional reporting by Maggie Lu Yueyang; Editing by Paul Tait, Eric Meijer and Jacqueline Wong)