(Reuters) -- A recent rise in loans to businesses is spurring hope that bank earnings reports, which begin Friday, will show that the outlook for this economically critical industry is better than its battered stock prices and weak investment banking volumes would suggest.

Loans by large banks to commercial and industrial companies picked up sharply through the last week of the year, according to Federal Reserve data, and in recent days have started to catch the attention of investors.

"Loan growth will be one of the hottest topics throughout the earnings season," said David Long, a bank stock analyst at Raymond James & Associates. A lasting upturn in demand for loans to finance investment would be good for the economy and, in turn, rebuild profits from consumer lending, investment banking and asset management.

Promising signs in loan portfolios, though, are expected to be countered by another rough patch for capital markets businesses. Banks are also still trying to shake off mortgage-related losses tied to the housing bust and struggling to increase revenue in the face of new regulations that crimp the fees they can charge for debit card swipes.

JPMorgan Chase & Co., the biggest U.S. bank, is scheduled to report fourth-quarter and full-year results Friday morning, kicking off the earnings season for financial companies. The report will break out results from JPMorgan's large investment banking, business lending, and consumer franchises which could foreshadow earnings reports in the next two weeks from companies concentrated in those segments.

Bank of America Corp. , Citigroup Inc. , Wells Fargo & Co, Goldman Sachs Group and Morgan Stanley are to report the following week after the Martin Luther King holiday.

JPMorgan is expected to report earnings per share that are 18 percent lower than in the same period a year earlier, according to analysts surveyed by Thomson Reuters I/B/E/S. Estimates for Bank of America, on the other hand, call for the bank to rebound from a loss at the end of 2010 amid a raft of unusual charges for bad mortgages.

Quarterly earnings for the broader financial sector represented by about 80 large companies, including insurance companies and money management firms, are expected to be down about 1.6 percent from a year earlier, according to Thomson Reuters I/B/E/S.

Bank analysts and investors, though, will be looking beyond year-ago profit comparisons to what institutions reveal about current profit margins for lending, cost controls, regulatory burdens and any change in demand from borrowers for money.

Weak demand from consumers who borrowed too much during the housing bubble has combined with tougher requirements from governments for financial safety to push bank stocks down to record low levels compared with the companies' earnings and net worth, also known as book value.

That's why solid new business loan growth could alter the industry's outlook. In fact, bank stocks are off to a strong start this year on hopes that the worst is behind the industry. Shares of Bank of America, down nearly 60 percent in 2011, have surged 24 percent as of Wednesday.

"If we do see some loan growth, that starts to reflect that the economy is starting to stabilize and we're starting to see some growth," said Marty Mosby, analyst with Guggenheim Partners. "As banks start to see some lending growth that turns into some job growth."

Outstanding loans to commercial and industrial businesses by large banks grew 5.2 percent in the fourth quarter through December 28, according to Federal Reserve data. That's more than a 20 percent annualized rate and an acceleration from the 3.1 percent and 3.4 percent increases in the two previous quarters, said Long.

To be sure, much of the increase was likely not so much additional demand from companies as it was a shift in market share of existing borrowings, said Long. European banks lending to U.S. companies backed away to trim their balance sheets in the sovereign debt storm. And, bond investors in the capital markets gave up some of the business when they were unwilling to refinance large loans as cheaply as large U.S. banks.

"It isn't an indication of super-charged growth," Mike Mayo, an analyst with Credit Lyonnais Securities Asia and author of "Exile on Wall Street: One Analyst's Fight to Save Big Banks from Themselves," said in an interview.

CONTINUING CHALLENGES

More business loans are especially important because loans to consumers and loans for commercial and residential real estate have declined from their levels a year ago, according to Paul Miller, an analyst at FBR Capital Markets.

Miller cautions that the earnings reports could include unpleasant surprises. For example, some banks may decide to take charges to clear their books of inflated values on assets before they start the new year. Charges like those won't be as easily offset as in the recent quarters when improving consumer creditworthiness allowed banks to reverse large reserves they had booked for bad loans.

"I don't think we will get the improvements in credit like we've seen in the past," said Miller.

Other challenges for banks in the fourth quarter, according to Miller, include reduced income from debit card swipe fees and tighter net interest margins - the spread between what banks make on loans versus what they pay on deposits.

To make up for lost revenue, banks are tightening their belts. Bank of America has said it will eliminate 30,000 jobs in the consumer bank and staff functions over the next few years. It's also preparing for cutbacks in capital markets and wealth management operations starting this spring. Wells Fargo is looking to reduce quarterly expenses by $1.5 billion by the fourth quarter of this year through a wide-ranging efficiency program, that also includes job cuts.

EUROPEAN UNCERTAINTY REMAINS

Analysts expect Goldman Sachs Group Inc and Morgan Stanley to report the worst annual earnings since the financial crisis, due to tremendous market volatility stemming from the European sovereign debt crisis. Big swings in stock and bond prices led clients to pull back sharply on trading and deal-making.

Overall investment banking revenue declined 9 percent across Wall Street compared with the third quarter, which was already weak, according to a report by JPMorgan analyst Kian Abouhossein. He expects banks to report a quarterly decline of 17 percent in dealmaking revenue, with a 3 percent drop in fixed income trading revenue and a 2 percent drop in equities trading revenue.

Investors remain concerned about Wall Street's exposure to Europe, as well as whether big banks' trading desks can earn more than their cost of capital, given market stress and new regulations that aim to cut back on risk-taking.

Goldman Sachs is expected to report fourth-quarter earnings of $1.50 per share, less than half of what it earned in the year-ago period, according to Thomson Reuters data. Morgan Stanley is expected to report a loss of 56 cents per share due to a special charge related to a settlement with MBIA Inc . It earned 41 cents a share in the year-earlier quarter.

Analysts do not see an end to the investment banking woes any time soon, which explains why both Goldman and Morgan Stanley have outlined plans to lay off staff and are expected to cut bonuses by billions of dollars to trim costs. Fourth-quarter reports will provide more insight on the compensation the firms have set aside for the year.

"Unfortunately," Brad Hintz, an analyst at the brokerage Sanford Bernstein & Co and a former Morgan Stanley treasurer, said in a recent report, "we do not anticipate a robust capital markets recovery in 2012."

(Reporting by David Henry in New York and Rick Rothacker in Charlotte, North Carolina. Additional reporting by Lauren Tara LaCapra in New York.)

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