* Emergency funding to stay as Greece readies reforms
* One week to go before big payment to ECB
* In case of default, ECB could cut funding
By John O'Donnell
FRANKFURT, July 13 The European Central Bank's decision to support Greece's shuttered banks by keeping its emergency funding line open gives the country's lawmakers a few days to seal reforms for an aid deal to keep it in the euro.
However, the lawmakers are under pressure to act fast as the ECB, facing resistance from Germany, would be unlikely to extend the funding line next week if Greece misses a debt repayment due to the ECB on July 20.
The lawmakers' support for tough reforms, agreed by leftist Prime Minister Alexis Tsipras on Monday after all-night talks, is crucial for starting the next phase of negotiations on a tentative aid deal, that will potentially unlock funds to help Greece make the roughly 3.5 billion euros ($3.87 billion) ECB debt repayment.
Missing that payment would likely force the ECB to turn off the 89 billion euro Emergency Liquidity Assistance that it agreed to extend again on Monday.
"The Greek parliament is being asked to surrender unconditionally," said one euro zone central bank official, suggesting that the ECB could change tack on emergency funding if action did not come soon.
"If they don't deliver by Wednesday, it's going to be tough."
The ECB is expected to gather again on Wednesday evening in Frankfurt to discuss whether to extend the line again, sources said.
The 89 billion euro line is enough to keep the banks afloat but only barely. Without that funding, the banks would collapse immediately, dragging Greece further into chaos, a possibility if Greece misses Monday's repayment.
In Germany, where pressure has been building to cut off the funding, the Bundesbank does not want the line to continue beyond July 20 if the ECB repayment is missed, a person familiar with its thinking said.
Continuing to provide funds if Greece were to default on money it owes the ECB would appear to breach central bank rules that say it must not provide direct financing to states. The Bundesbank is determined that this not happen.
In any case, the 89 billion euros line is not enough to resume business as usual or lift the strict rationing of cash. Officials at Greek banks are counting on the ECB to increase the funding line to free up liquidity to allow the banks to start to function again.
While the ECB is expected to cut the funding line altogether next week if the repayment is missed, it is unclear whether the ECB would reward Greece for fast-tracked reforms with an increase in the size of the funding line.
"Not providing any liquidity at all would seem extreme," one Greek banker said.
"There should be a move from the ECB to keep the banking system going for the next few days, so a bit of liquidity is likely."
Extra money might require a guarantee from euro zone countries to underpin the collateral Greek banks give for the funding, something they last did in 2012.
CAPITAL CONTROLS TO STAY
Volker Wieland, one of the 'wise men' who advise the German government on economic policy, said an increase was possible but even if there was one, money controls would stay.
"It gives them the opportunity to keep up the emergency liquidity assistance," he said. "They can maintain it, they can even increase it slightly but the Greek government can certainly not lift capital controls."
Even with an increase in liquidity, capital controls would only be lifted gradually, another official said.
"You don't want to create room for a bank run that would create a bigger mess," the central bank source said.
Sorting out the banks, starved of cash after months of crisis and economic uncertainty, is essential to getting the Greek economy back on its feet. The Eurogroup of finance ministers estimated that any new bailout programme for Athens would require up to 25 billion euros to recapitalise its banks.
One of the preconditions imposed on Greece for a deal is that it signs into law European rules that would put euro zone authorities at the ECB and in Brussels, rather than Athens, in charge of identifying and closing or breaking up sick banks.
This in turn could lead to a shake-up of the sector that could see some banks close, with losses pushed onto bondholders and possibly even large depositors. In such circumstances, there would be little that Athens could do to prevent this.
One European official had told Reuters that the number of big banks in the country could be reduced from four - National Bank, Piraeus, Eurobank and Alpha - to as little as two.
Greek bankers say that reducing the number of lenders would raise competition issues. ($1 = 0.9053 euros) (Additional reporting by Francesco Canepa and Balazs Koranyi in Frankfurt, Paul Taylor in Brussels, George Georgiopoulos in Athens and Carmel Crimmins in Dublin; editing by Anna Willard)