(Updates share prices)

By David Dolan

TOKYO, Jan 7 (Reuters) - Japan's government may inject money into scores of regional banks, a newspaper said on Wednesday, sending shares of small lenders such as Tokyo Tomin Bank (8339.T: Quote, Profile, Research) sharply higher, even as the government dismissed the report.

The government could give 40 or more local banks handouts to boost their capital and make them more willing to lend out money amid the credit crunch, the Mainichi newspaper said.

But an official at the regulatory Financial Services Agency said Tokyo was not currently considering a broad injection of public funds. The government has recently eased rules to encourage local banks to apply for public money.

Japanese banks, especially the small lenders that depend on fragile, regional economies, have become increasingly wary about lending as the global downturn hits home.

Saddled with rising bad loan costs and a dwindling customer base, local banks have also been hit by heavy exposure to languishing domestic stocks.

"Even though there are obviously a few problems, they don't pose a major systemic threat," Jason Rogers, credit analyst at Barclays Capital, said of Japan's regional banks.

Analysts have long said that rural Japan is overbanked -- many prefectures are home to several local lenders -- and that broad consolidation of regional banks in necessary.