UPDATE 1-BOJ Shirakawa: Japan corporate finance still tight

* Japan financial systems calmer, banks need close monitoring

* CP, corporate bond markets improving but corp finance tight (Adds comments, details)

TOKYO, July 6 - Bank of Japan Governor Masaaki Shirakawa said on Monday that Japan's financial system was on the whole becoming calmer with strains in financial markets both at home and overseas easing, but many firms still faced tight funding conditions and a severe lending attitude by banks.

The Japanese economy has begun to stop worsening and is likely to show clearer evidence of levelling out as exports and industrial output are expected to continue to recover and public investment will keep increasing, Shirakawa said.

Shirakawa's remarks come after the BOJ's tankan corporate survey released last week showed that Japanese business sentiment improved less than expected in June while the corporate finance market, which seized up after the collapse of U.S. investment bank Lehman Brothers in September, was on the mend.

"Looking at Japan's financial conditions, the environment surrounding the issuance of CP and corporate bonds is improving further, and bank lending mainly towards big firms has been rising at high levels," Shirakawa said in a speech to a meeting of the central bank's regional branch managers.

"Many firms still face a tight funding and lending attitude from banks, although there are signs that the trend has stopped deteriorating," he said.

The tankan's financial conditions index for large companies rose 5 points to plus 1, the first improvement in eight quarters, while the gauge of conditions for commercial paper issues gained for the first time in six quarters.

But analysts say that was not enough to persuade the central bank to end corporate finance support in September, when some steps are due to expire, given growing investor concern that Japan is slipping deeper into its second spell of deflation this decade.

Shirakawa said on Monday that Japanese banks needed close monitoring, and their business strength is increasingly varying.

Japan's three largest banks lost a total of 1.2 trillion yen ($12.50 billion) in the year that ended in March.

The BOJ upgraded its economic assessment for the second straight month in June, as improvements in exports and output fuel hopes that the worst of the recession is over.

It has kept interest rates at 0.1 percent since cutting them twice last year in the wake of the global financial crisis. With financial strains easing, markets are focusing on whether the BOJ will extend corporate finance support beyond September.

The central bank's policy board next meets on July 14-15. ($1=96.03 Yen)