UPDATE 1-BOJ may eye more municipal bonds as collateral-Nikkei

* BOJ may eye privately placed municipal bonds as collateral

* Such a move could help regional banks boost lending

TOKYO, April 6 - The Bank of Japan may discuss expanding the type of municipal bonds it accepts as collateral in its market operations at a two-day rate review ending on Tuesday, the Nikkei business daily reported on Monday.

Analysts say any such move could help regional banks -- hard-pressed as a deepening recession pushes many small companies into bankruptcy -- raise money more easily and boost lending to such customers.

The BOJ currently accepts only publicly placed municipal bonds as collateral but could expand that to include such bonds issued privately to financial institutions, the paper said without citing sources.

"Regional banks may not hold a lot of government bonds that they could use as collateral, but they do tend to hold a lot of municipal bonds," said Hirokata Kusaba, senior economist at Mizuho Research Institute.

"This is a policy designed to improve liquidity at smaller banks and I am sure they would welcome it. It could be seen as a pre-emptive measure the BOJ is considering just in case credit markets start to tighten again around earnings season."

In the bond markets, which were focused on the prospects of a global economic recovery, the benchmark 10-year government bond yield rose to a 4-½ month high.

June 10-year Japanese government bond futures fell 0.32 point to 137.09 after hitting 136.99, the lowest since Nov. 10.

Privately placed municipal bonds, issued by regional governments and held mostly by regional banks, had been excluded as collateral in market operations due to their low liquidity.

Adding such bonds to the list of collateral the BOJ accepts would be more a tinkering move on the margins than a drastic move to flood the banking system with liquidity.

The BOJ is expected to keep interest rates on hold at 0.1 percent at the two-day rate review that kicked off on Monday but could discuss what more it can do in future as business confidence slumps to record lows.

The central bank has already started buying commercial paper and corporate bonds from banks to prompt them to lend more. While these steps have eased funding for big firms, many smaller firms remain cash-strapped as banks are hesitant to take on risk.