UPDATE 2-Bank of Canada unwinds another emergency measure

* BoC tightens collateral eligibility rules

* Says market conditions improving

By Louise Egan

OTTAWA, Nov 5 (Reuters) - The Bank of Canada backtracked on Thursday from relaxed collateral rules that were introduced during the credit crisis, in the latest sign it believes market conditions have thawed.

In October 2008, as funding markets seized up, the bank announced it would start accepting non-mortgage loan portfolios as collateral for its Standing Liquidity Facility (SLF) and Large Value Transfer System (LVTS) on a temporary basis.

The LVTS is used to settle balances between banks.

The measure was designed to give banks greater flexibility in managing their collateral and boost overall liquidity in the system. The central bank had promised to maintain the eligibility rules until at least Feb. 2, 2010.

It has now decided to gradually tighten the rules, reducing the non-mortgage loan portion of each participant's eligible collateral to 20 percent from 100 percent by April 2010.

A new limit of 80 percent of the total will come into effect as of February 2010. It will be reduced to 50 percent as of March and finally to 20 percent as of April and on a permanent basis.

"As part of its ongoing review of the collateral policy for the SLF, the Bank has determined that there are efficiencies associated with limited use of the non-mortgage loan portfolio for LVTS and SLF collateral purposes on a regular basis," it said in a statement.

WINDING DOWN PROGRAMS

To combat the recession and credit crisis, the Bank of Canada also cut its benchmark interest rate to a record low of 0.25 percent and introduced three temporary liquidity facilities for markets.

At their peak, it injected a combined C$44.3 billion ($41.4 billion) into markets through those measures.

But it has begun unwinding these extraordinary measures as short-term lending markets improve both domestically and abroad.

The three-month Canadian dealer offered rate CA3MBAFIX=CDOR, similar to the key Libor (London interbank offered rate) used in other markets, fell from around 3.73 percent in October, 2008, to just 0.433 percent on Thursday, according to Thomson Reuters data.

The Bank of Canada discontinued two of the temporary facilities at the end of last month. The third, a term purchase and resale agreement (PRA) under which the central bank buys securities in the market with an agreement to resell them at a later date, will continue until the end of January 2010 when the bank will decide whether or not to extend it.

There is currently about C$27 billion outstanding under the term PRA.

The bank has pledged to keep its overnight interest rate at its current level until the end of June 2010, on the condition that inflation does not stray off track.

($1=$1.07 Canadian) (Editing by Jeffrey Hodgson)