* Number of French, Belgian bank stocks on loan falls after end of ban
* Weaker Italian Spanish lenders worst off
* BMPS eyed by short sellers; put buyers like Santander, BBVA
By Michel Rose and Alessandra Prentice
LONDON/MILAN, March 14 (Reuters) - Short-sellers have returned to target specific banks in the weeks since bans on the trade were lifted in several euro zone countries, after a central bank cash splurge helped near-term fears about the health of the broader sector recede.
The number of bank shares on loan since bans on short-selling financial stocks in four euro zone countries were lifted show a growing investor focus on fundamental rather than macroeconomic pressures on banks, data showed this week.
Bans on short-selling -- where investors sell a borrowed stock with the aim of buying it back at a lower price -- by France, Italy, Spain and Belgium to help protect lenders from speculative attack as a result of the financial crisis were all lifted in February.
The average amounts of financial stocks out on loan -- a strong indicator of shorting interest -- in France and Belgium are lower than before the ban was introduced, figures from securities lending research firm Data Explorers showed, while those on banks with weak balance sheets in debt-laden Italy and Spain have risen.
Cash injections from the European Central Bank, through its Long Term Refinancing Operations (LTRO), helped shore up the financial health of the sector as a whole, boosting the main index more than 19 percent since the start of the year, but peripheral euro zone banks with weaker balance sheets still look vulnerable to short-sellers.
"Banks are in better shape since the LTRO came out and the show has moved on - it's difficult shorting when there's so much political indecision going on," said Will Gordon, research director at Data Explorers.
"Any increase in short-selling will be on the fundamentals of a particular bank in question," Gordon said, adding that Italian bank shares were among those that had attracted particular interest since the lifting of the ban, especially those with shares on loan already.
Italy's Banca Monte dei Paschi, Italy's No. 3 lender, is among the firms under the short-selling spotlight as 4.3 percent of its stock is out on loan, almost double the amount of shares compared with before the enaction of the ban in August 2011.
That is the third-biggest rise in short interest, Data Explorers data showed, after smaller lenders Banco Popular Espanol and Banca Carige, and compares with an average of 1.2 percent of Italian equities on loan by March 7.
Monte Paschi is the world's oldest bank and regarded as one of Europe's most vulnerable as its return on equity is a lowly 2.4 percent and it faces a capital shortfall of 3.3 billion euros ($4.3 billion) to meet tougher European regulatory rules.
Another Italian bank, Banco Popolare, is the second-most shorted financial stock from the four countries who recently lifted their bans, with 11.4 percent of shares out on loan, after Banco Popular Espanol's 11.5 percent.
The Italian lender was already heavily shorted before the ban with 7.7 percent of shares on loan and short interest has risen since the end of the ban as investors seem to doubt its CEO's insistence that the bank would not need a capital increase to meet tougher European capital requirements.
"With Italy expected to experience a recession this year, banks with heavy domestic exposure will see the quality of their assets fall, and provisions rise," a Paris-based analyst said.
"Popolare and Monte Paschi are essentially Italian, their foreign exposure is marginal, unlike UniCredit, so you can see why they would attract speculative interest. Popolare still expects asset sales to boost their capital ratios, but it's not easy to see how they can do that in this type of environment, which is making investors nervous," he added.
This contrasts with French and Belgian financial stocks, which have seen lower short interest since the ban was lifted, as last summer's fears about the solvency of French banks, which led to brutal share drops at Societe Generale and BNP Paribas, proved unfounded.
On average, the percentage of stock on loan since the bans were lifted has also increased more in the Spanish and Italian financial names than those in the wider market, as banks in these two countries, because of their domestic exposure, are often seen as the best proxy to bet on a sharper recession.
However, share prices have not always moved in line with short-sellers' wishes. In Italy, even though financial stocks attracted more short interest than the wider Milan market since the ban was lifted, banking shares have actually outperformed the FTSE MIB index, the data showed.
The Italian banking sector is up 3.6 percent since market regulator Consob let the ban expire on Feb. 24, in line with the strong performance of its bond market.
The ECB's two rounds of cheap cash injection helped Italian banks more than their Spanish peers, which are down 6.6 percent overall since the Spanish ban was lifted on Feb. 15, reflecting the market's new focus on Spain's troubles rather than Italy's.
But one London-based fund of hedge fund manager said the rise in short-selling of some bank stocks could be put down to pair trading, where funds use the short to hedge long positions elsewhere, in the bond market for instance.
"A lot of this year has been about managers increasing (their) exposure from a very low base, both on the long and the short side," he said.
Demand for put protection, where investors purchase the option to sell a stock at a set price in case of a sharp sell-off, has risen since the end of the ban on short-selling, said Kokou Agbo-Bloua, European head of equity and derivatives strategy at BNP Paribas.
"There's a bigger focus on put protection on financials, especially on Spanish banks since the short-sell ban was lifted... particularly since a lot of financials have rallied by roughly 30 percent from their lows mid-December with the LTRO," he said.
Spanish banks BBVA Santander have seen a marked rise in put options being taken out on their stock, Agbo-Bloua said, adding that Spanish bank stocks are seen as being more vulnerable due to market concerns over non-performing loans and high unemployment in Spain.
"A lot of people are trying to protect their gains by buying protection on the financials and there's a few more worries with respect to Spain," he said.
$1 = 0.7610 euros Additional reporting by Tommy Wilkes; writing by Simon Jessop