UPDATE 3-Lloyds says could quit UK govt insurance scheme
* Says may reduce number of assets in protection scheme
* Says discussing alternatives to asset scheme * Lloyds shares down 0.5 percent, sterling falls vs euro (Adds currency impact, further background, updates shares)
LONDON, Sept 18 (Reuters) - Britain's Lloyds Banking Group (LLOY.L) said it may scale back or cancel its participation in a state-backed scheme to insure it against credit losses, as a healthier economy has improved the outlook for bad debts.
The part-nationalised bank on Friday confirmed for the first time that it was in talks with the government and the financial regulator over "possible alternatives" to the so-called asset protection scheme (APS), without providing further detail.
"All possibilities remain open," Lloyds said.
Industry sources said last month that Lloyds was exploring ways of sidestepping the scheme, seen as expensive and potentially unnecessary following an upturn in the economy since it was first negotiated in March.
But analysts say an outright withdrawal from the programme would be difficult as the bank would have to raise up to 20 billion pounds ($32.70 billion) of fresh capital -- representing the biggest cash call on record -- to satisfy regulators that it could absorb further credit losses on its own.
CAPITAL QUESTION
"The idea of Lloyds exiting the APS is unlikely primarily because raising 15 to 20 billion pounds isn't a viable option," said Exane BNP Paribas analyst Ian Gordon.
"The consensual position in the market is that Lloyds will end up with a hybrid of a slightly scaled-back APS, plus some capital raising."
Reuters reported on Thursday that the Financial Services Authority had set tougher-than-expected capital conditions on Lloyds' potential exit from the scheme, making an outright departure less likely. [ID:nLH721093]
Two of Lloyd's biggest shareholders told Reuters last month that there was little enthusiasm for a cash call from the bank, which has already raised 4 billion pounds from investors this year. [ID:nLA282962]
Lloyds shares were down 0.5 percent at 109 pence by 1140 GMT, while the FTSE 100 share index was flat.
Earlier, the pound fell to a four month-low against the euro as news of the tighter terms for Lloyds' potential APS exit underlined the fragility of the banking sector. [ID:nLI493616] Continued...
