UPDATE 1-Bank of England lending scheme improves in second quarter

* Banks have drawn down 17.6 bln stg from FLS scheme

* RBS, Santander continue to cut lending

LONDON, Sept 2 (Reuters) - Net lending by banks and buildingsocieties taking part in the Bank of England's Funding forLending Scheme (FLS) was 1.6 billion pounds ($2.5 billion) inthe second quarter, an improvement on the previous three months.

In the first quarter, banks took more cheap funds from thescheme than they lent to customers, shrinking net lending by 300million pounds.

Banks have drawn down 17.6 billion pounds of cheap fundsfrom the FLS, set up to stimulate lending to UK households andbusinesses, since it opened last August.

However net lending has fallen by 2.3 billion pounds overallsince June 2012.

Paul Fisher, the central bank's executive director formarkets, said the scheme was continuing to support lending tothe UK economy with a range of indicators suggesting that creditconditions were steadily improving for housholds and companies.

"FLS participants collectively expect net lending volumes topick up over the remainder of this year," he said.

The biggest net lenders during the quarter were Nationwide, Lloyds Banking Group, Virgin Money andBarclays, according to Bank of England data.

State-backed Royal Bank of Scotland and Spain'sSantander continued to significantly cut their netlending, however. Santander has cut its net lending by 10.4billion pounds in the last year, and RBS has cut its net lendingby 6.8 billion.

RBS is attempting to shrink its balance sheet, whileSantander is using more of its capital for business lending andas a result has cut its residential mortgage lending.

Lloyds Banking Group, which is Britain's biggestretail bank and is 41 percent owned by the government, returnedto positive lending in the second quarter, with net lending of1.3 billion pounds.

Building society Nationwide was the biggest net lender, with2.3 billion pounds lent.

Barclays and Nationwide were in June ordered to improvetheir leverage ratios by the Bank of England, however, whichcould have the unintended consequence of slowing their lending.

Barclays and Nationwide has each lent more than 7 billionpounds net in the last year, over three times more than the nextbiggest lender.