* Bank of Italy says recovery "slow, fragile", needs reforms
* Calls for measures to fight corruption, tax evasion
* Says bank credit still contracting, bad debts rising (Adds comments, details on banking sector)
By Gavin Jones and Valentina Za
ROME, June 19 Italy's economy should improve gradually in the next few quarters as internal demand supports growth, but the outlook remains fragile and uncertain, a senior official at the country's central bank said on Thursday.
"Albeit in a situation of uncertainty, the conditions exist for a gradual improvement in economic activity in the next few quarters," Bank of Italy Deputy Director General Fabio Panetta said in a speech in Rome.
Italy's economy shrank 0.1 percent in the first quarter after emerging from a two-year recession at the end of last year, with fourth-quarter growth of 0.1 percent.
Central bank projections showed industrial output probably rose in the second quarter of this year from the first, Panetta said, although he did not offer a numerical forecast. Output rose 0.1 percent in the first quarter after increasing 0.5 percent in the fourth quarter of 2013.
The European Central Bank decision this month to offer cheap long-term loans to banks and maintain an accommodative monetary stance should offset the risk of excessive euro appreciation, Panetta said. That could increase Italian growth 0.5 percentage points by the end of 2016, he said.
The current signs of a "slow and fragile" recovery must be strengthened by structural reforms to support the economy, Panetta said.
In particular, he called for measures to improve the efficiency of the public administrations and to increase respect for the law by fighting corruption, tax evasion and crime in general.
Italy, the most sluggish economy in the euro zone since the start of the century, ranks 69 out of 177 countries in Transparency International's corruption index, below most European and developed countries.
Prime Minister Matteo Renzi, who took office in February, has set out an ambitious agenda to reform Italy's political institutions, labour market and public administration. So far, little of his programme has been implemented.
Turning to the banking sector, Panetta said banks may be holding back on lending because of uncertainties created by a pan-European review of euro zone banks now under way.
He warned that banks could cut lending further if the review were to uncover capital shortfalls. He said governments, including Italy's had still not set up tools to help lenders who are unable to raise necessary funds from the markets.
The outcome of the review will be announced in the autumn.
Panetta said that credit growth was essential for recovery to take hold in Italy. He noted that loans continued to contract partly because of weak demand but also due to worsening credit quality.
About a quarter of bank loans to companies in Italy showed some repayment anomaly, he said, a 10 percentage point increase over the past two years.
Starting from September, the ECB will offer banks in the region up to 400 billion euros in longer-term funds to encourage them to lend more to companies. (Reporting By Gavin Jones and Valentina Za; Editing by Larry King)