"It's difficult for it (ECB) to do more. It's now up to the banking sector to put in place the recapitalisation process needed to restore trust and sustain growth," Bini Smaghi said in a speech in San Casciano Val di Pesa outside Florence.

Bini Smaghi said the banking system could not sustain itself indefinitely on central banks' extraordinary measures, and urged those that do not take up government funds to find alternative sources so they can boost lending when the economy improves.

He also said loans to companies could fall further before the situation improves, with a turning point seen next year.

"Given current forecasts for stabilization of economic activity in the second half of this year, the growth of loans could reach a turning point no earlier than the beginning of 2010," he said.

Economic recovery "should proceed in a gradual and discontinuous way" in a context where uncertainty remains high and where the financial leverage of the banks could fall further, he said, citing forecasts by international groups.

Bini Smaghi said significant risks remained for euro zone banks "some of which could even increase."

He cited low growth in banking activity limiting banks' future investment capacity while credit quality deterioration could hurt their ability to produce profits.

(Reporting by Silvia Ognibene, writing by Stephen Jewkes and Deepa Babington, editing by Will Waterman)