(Repeats story first filed March 26)

* Euro-zone bank lending expected to turn positive soon

* Recovery seen tempered by structural issues, risk aversion

* ECB is selling cheap loans to banks to encourage them to lend

* Cheap ECB funding used to refinance existing business loans

By Sarah White and Valentina Za

MADRID/MILAN March 26 (Reuters) - The euro zone credit cycle is a whisker away from turning positive but don't expect a rapid recovery.

Bank lending to the private sector fell 0.1 percent in February, data from the European Central Bank (ECB) showed on Thursday, dashing expectations for an increase but inching ever closer to positive growth after nearly three years of contraction.

While ECB President Mario Draghi hailed a resurgent demand from companies for credit this week on the back of his cheap loans for banks, lenders and businesses are more circumspect about the prospects for a strong upswing.

"The scope of lending is not really widening, it's more credit for the same companies," said Camilo Pereira, chairman of one of Spain's biggest garden centre businesses, Fronda, which has dealings with half a dozen banks.

Banks' unwillingness to lend and businesses' reluctance to take on fresh debt have been at the heart of euro zone stagnation. A resumption of credit growth would signal a big hurdle to the bloc's recovery had been lifted.

The ECB has been throwing money at the problem, keeping interest rates at record lows and offering banks hundreds of billions of euros in cheap loans to lend more to businesses.

But funding is not a problem for the banks. Their funding costs have been down at pre-debt crisis levels for more than six months as yield-hungry investors snap up bank debt.

The problem is capital.

Making fresh loans requires lenders to set aside more capital to cover the risk of default, a tall order for some banks in the euro zone, where a new European banking regulator is taking a tougher stance on capital levels and capital quality.

Unlike the United States, which moved quickly to close struggling lenders and recapitalise the healthy ones in the wake of the financial crisis, Europe, where many smaller lenders are politically connected, has failed to take a big bang approach.

The International Monetary Fund has estimated that nearly three-quarters of the euro zone's 3,600 plus banks need to be overhauled before they can meet the demand for credit when the euro zone economy fully recovers.

In Italy, bad debts are still climbing, making it even more difficult to make new loans, as bankers in some regions hope that a resumption of economic growth will resolve the issue.