The Bank of Japan is expected to keep monetary policy on hold on Tuesday but consider ways to funnel more money to firms with growth potential, keeping up efforts to address chronic ills that plague an economy hit by a devastating earthquake in March.

The central bank will examine adding up to 1 trillion yen ($12 billion) to a 3-trillion-yen loan scheme aimed at encouraging banks to lend to industries with growth potential.

The increased amount would be set aside for banks that lend against inventory and receivables as collateral. That would give small firms that do not own property -- a standard collateral for bank loans -- better access to cash.

The BOJ may use the program as a vehicle to assist with reconstruction from the quake, which is set to kick off in full force around the autumn. Any such move would be a long-term approach to nurture growth industries in Japan, which is suffering from an aging population, low productivity and grinding deflation.

Japan is slowly emerging from its worst crisis since World War Two after a magnitude 9.0 earthquake and a tsunami slammed its northeast coast on March 11, triggering meltdowns at a nuclear power plant and pushing the economy into its second recession in three years.

The central bank, which responded by doubling its asset buying plan to 10 trillion yen, is widely expected to hold off easing monetary policy further and to keep interest rates at a range of zero to 0.1 percent.

The BOJ has said that while the economy was badly hurt by the disaster it was poised for a gradual recovery later in the year.

The BOJ probably won't feel the need to take additional easing steps given that the economy is performing in line with its forecast, said Junko Nishioka, chief economist at RBS Securities in Tokyo.

A government survey of big Japanese manufacturers supported the recovery scenario with business sentiment taking a hit in the April-June quarter but firms ramping up capital expenditure plans for the fiscal year that started in April.

The loan scheme for growth industries is the BOJ's long-term approach to beat deflation and is separate from its asset buying program, introduced in October 2010 as a direct, short-term monetary easing measure.

Shortages of electricity could disrupt some manufacturing activity in the summer, but companies have been making progress in restoring lost production and mending supply chains.

Encouraged by the steady progress in which manufacturers are repairing supply chains, the BOJ may issue a less pessimistic view of the economy than last month, when it said it was under strong downward pressure.

The recent global economic slowdown is a potential risk but not enough to alter the BOJ's view that Japan's economy will resume a moderate recovery by the end of this year when supply constraints ease, said sources familiar with the central bank's thinking.

Under the loan scheme targeting growth sectors, the BOJ offers 0.1 percent loans for up to four years to banks that lend to 18 industries with growth potential such as clean energy and nursing care.

The board will consider topping up the program with only 60 billion yen left to lend even though four more tranches are planned before the scheme expires in March next year.

But some in the central bank, including board member Seiji Nakamura, are wary of boosting the scheme. Regional banks have said the program was depressing lending rates without substantially improving small firms' access to cash.

The board will therefore consider ways to funnel more funds to small firms, the sources said.

(Editing by Tomasz Janowski)

Japan