* Probe impact on iron ore prices to help steel producers
* Sees iron ore prices around $100 a tonne in medium term
* Financing probe carries risk of sell-off, price fall-traders (Adds analyst and trader quotes)
By David Stanway and Ruby Lian
BEIJING/SHANGHAI, April 30 (Reuters) - A Chinese probe into the use of iron ore for financing could help local steelmakers by cutting prices of the raw material, the country's biggest listed steelmaker Baoshan Iron and Steel (Baosteel) said on Wednesday.
However Baosteel, which has long complained about the high cost of iron ore, said it still expected prices to hold around $100 a tonne in the medium term, not far below current levels, despite a big increase in output by miners.
The China Banking Regulatory Commission has ordered an investigation into the use of iron ore as collateral in financing deals, a move that prompted a steep fall in iron ore futures this week as investors feared a crackdown that would curb demand.
Iron ore futures fell 4.5 percent on Monday, but have since steadied as the market awaits any further action.
"Financing deals on imported iron ore are facing risks, but as far as steel manufacturers are concerned, if the loosening of these risks can bring iron ore prices back to a rational level, it can only be a good thing," Baosteel chairman He Wenbo said after the company reported a 7 percent fall in quarterly profit.
China's steel industry, by far the world's biggest, suffers from chronic overcapacity and the government is attempting to curb output by closing smaller, higher-polluting mills.
Baosteel's He said moves by banks to cut loans to the steel and iron ore sector were part of efforts to reduce liquidity and help implement environmental policies, but were unlikely to have an impact on big, high-end steel producers.
Analysts said a potential crackdown on iron ore financing and a widening supply surplus in the second half of the year could still lead to further falls in iron ore prices.
"Port inventories are too high and overseas supplies will increase by a large amount from the second half," said Fu Yang, an analyst with Shanghai's Guotai Junan Futures.
"For steel mills and traders, the problem is that banks are still squeezing credit and if they can't repay loans when the letter of credit is due, they will have to sell iron ore to obtain cash, which might cause overselling in market and drag down prices to maybe even $90 a tonne."
China's iron ore imports surged 19 percent to a record 22 million tonnes in the first quarter.
There are no reliable figures on how much of this has been used for financing purposes, but iron ore inventories have swelled to record levels above 108 million tonnes over past few months.
Traders said a large number of iron ore port inventories were purchased using letters of credit at about $130-$140 a tonne in December and January, compared with current spot prices around $105-106.
Traders and mills, which are already struggling with cash flow, are expected to repay loans in May, raising market fears that they might have to sell their stocks to survive if banks decide to further raise the size of the deposit needed to obtain credit or cut access to credit.
"There are more steel mills starting to resell iron ore cargoes that they have purchased from global miners on annual contracts at index plus to lock in profit and get cash," said an iron ore buying official with a state-owned steelmaker.
Baosteel's He said the steel sector would continue to struggle, but the company did not expect new central government measures aimed at stimulating demand.
Big Chinese steelmakers made combined losses of 2.33 billion yuan ($372.59 million) in the first quarter, as weak demand and overcapacity cut prices.
"To prevent investment from falling too quickly, a number of big infrastructure projects like railways will be steadily pushed forward, and monetary policy could also be relaxed a little," he said.
Baosteel forecast total crude steel output to rise by 3.8 percent to 809 million tonnes in 2014, He said. Apparent steel consumption was expected to reach 752 million tonnes, up 3.3 percent on the year. (Reporting by David Stanway and Ruby Lian; Editing by Richard Pullin)