UPDATE 2-Japan sets up $3 bln cash lifeline for small firms

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* Japan offers help with small firms' dollar funding

* Policy-makers on alert over corporate finance

TOKYO, May 26 (Reuters) - Japan threw another lifeline to small firms in need of cash dollars by promising to channel funds from a government-affiliated bank even as credit market conditions show signs of improvement.

Finance Minister Kaoru Yosano said on Tuesday that the Japan Bank for International Cooperation (JBIC) would provide around $3 billion in loans to small Japanese firms operating overseas to help them raise cash in the U.S. currency.

"I expect funding needs of around $3 billion from small firms," Yosano told a news conference.

Although strains in financial markets have been easing in the past few months, Japanese policy makers remain concerned about funding conditions of many companies.

Bank of Japan Governor Masaaki Shirakawa also said on Monday that the central bank would keep monitoring funding conditions for companies.

The bank's tankan corporate survey last month showed Japanese companies regard funding conditions as the tightest in around a decade.

Small companies are being hit particularly hard as banks fret over rising bankruptcies among them as the Japanese economy struggles with its worst recession in decades.

The measure, which will be in place until the end of March 2010, adds to a series of government steps to support corporate fundraising amid tight credit markets worldwide.

JBIC, the international wing of state-owned bank Japan Finance Corp, will offer five-year loans to overseas subsidiaries, mostly in Asia, of small Japanese firms.

JBIC has been providing loans to exporters dealing in emerging economies and big firms operating in developing countries since late last year to help them secure dollar funding.

The government has also taken steps to help companies raise yen in cash, including offering 30 trillion yen ($316.5 billion) to guarantee loans to small firms and setting up a 20 trillion yen loan facility via government-affiliated banks.

The central bank has been buying commercial paper and offering cheap funding to banks against corporate debt collateral.

Thanks in part to those measures, funding conditions for big companies have improved sharply in the past few months, with the rate on commercial paper falling to a 2-1/2-year low.

But analysts say many small firms are still being left out in the cold and the recession is expected to take its toll on them.

The economy contracted a record 4.0 percent in January-March on falls in capital spendings and exports.

While the worst may be over for the export-driven Japanese economy given some signs of stabilisation in the global economy, any recovery will be fragile and mild in the near future as the damage the credit crisis has wrecked on the global demand is big, analysts say. ($1=94.79 Yen) (Reporting by Hideyuki Sano; Editing by Michael Watson)