* Measures to broaden collateral pool in the works-sources
* Firms make large use of current account credit facilities
* Form of lending estimated to account for quarter of total
By Valentina Za and Francesca Landini
MILAN, May 12 (Reuters) - The Bank of Italy aims to improve financing conditions for small businesses through new measures that would enable domestic banks to use their current account facilities to secure European Central Bank funding, banking sources said.
The small- and medium-sized enterprises (SMEs) that are the backbone of Italy's economy rely almost exclusively on bank financing. But loans to firms have shrunk by 71 billion euros ($98 billion) since mid-2011, when Italy was sucked into the euro zone debt crisis.
They are still contracting, central bank data shows, impeding the recovery in the euro zone's third-largest economy.
The measures the Bank of Italy is expected to unveil next month seek to broaden the range of assets banks can use as collateral against ECB loans.
By targeting current account facilities, which allow small businesses to borrow up to an agreed amount while they are waiting for customers to pay them for their goods or services, the Bank of Italy is trying to channel ECB loans towards small domestic banks that play a key role in financing small businesses.
These facilities were estimated to provide up to 180 billion euros ($248 billion) in funds to firms last year, one of the sources said.
"The new measures could be particularly beneficial to smaller banks and small firms that make extensive use of these credit facilities," the source said.
The Bank of Italy declined to comment.
"[It is correct that] that the Bank of Italy is looking at ways to expand the collateral pool, within the boundaries of the Eurosystem collateral framework," an ECB spokesman said. "The ECB and the relevant Eurosystem committee are fully involved."
As part of extraordinary liquidity measures announced in December 2011 at the height of the euro zone crisis, the ECB has allowed national central banks to accept additional bank loans as collateral.
The loans must be performing and the risks of accepting them remain with national central banks.
Italian banks have 215 billion euros of assets pledged in exchange for ECB loans. They have another 334 billion euros they could use to borrow more. These assets, mainly government bonds, are mostly in the hands of larger banks while the vast majority of Italy's 684 lenders are small.
The largest 20 banks accounted for 90 percent of total banking assets at end-2012, think-tank Prometeia calculates.
The planned new rules targets credit facilities allowing companies to draw from a current account up to an agreed limit.
In order to qualify as collateral with the ECB, the banks can only use that portion of the credit line firms have drawn down. And only once they modify the facility according to guidelines the Bank of Italy will issue.
The key obstacle that makes these credit lines currently unsuitable as a guarantee for ECB funds is the fact that, contrary to standard loans, they don't have a set maturity.
However, setting a maturity for the credit lines would weigh on banks' capital and liquidity ratios, forcing lenders to put aside more capital against this type of assets.
Regulators are therefore looking at a number of options to address the problem, the sources said without elaborating.
Banks have been briefed about the upcoming regulatory changes and are exploring potential benefits, another source with knowledge of the matter said.
"It is too early to draw any conclusions," the source said.
In a separate initiative, investment banks such as JPMorgan have looked into ways to allow Italian banks to use these same credit lines as assets to back debt issues. Also in this case the main hurdle is the lack of a maturity. JPMorgan declined to comment.
$1 = 0.7205 Euros Additional reporting by Eva Taylor in Frankfurt. Editing by Carmel Crimmins and Louise Heavens