* Italian banks borrowed more euros from the ECB in October

* Borrowings could rise further as BTP/Bund spreads widen

* Take-up of ECB loans on Tuesday in line with expectations

* Demand seen low at ECB's three-month dollar tender

By Marius Zaharia

LONDON, Nov 8 (Reuters) - Italian banks' reliance on European Central Bank funding is poised to increase as Italian bond yield levels head towards unsustainable levels amid signs that the euro zone crisis is worsening.

Data showed on Tuesday that ECB funding to Italian banks increased to 111 billion euros in October from 105 billion in September -- almost three times the amount in June.

Giuseppe Maraffino, rate strategist at Barclays Capital, said he expected the figure to rise further.

"As long as uncertainty remains high and the spread of BTPs (Italian Bonds) versus Germany continues to widen, the use of the ECB facility by Italian banks is likely to remain high," he said.

"This is mainly related to the sovereign crisis, not to the health of the banks."

Italian government debt costs have risen steadily and Prime Minister Silvio Berlusconi's political future remains in the balance even after he won a key parliamentary vote on public finances on Tuesday.

While Berlusconi is generally perceived by investors as reform-shy, the political uncertainty may make the ECB hesitate to step up purchases of Italian bonds.

That means their benchmark yields could rise from current levels around 6.6 percent towards 7 percent, the level beyond which Greece, Ireland and Portugal were forced to seek financial aid.

The sharp yield spike brought the spread over an average of triple-A rated bonds to what analysts say are levels close to triggering an increase in the margin required by repo clearing house LCH.Clearnet.

In repo markets, the general collateral (GC) rate for Italy was 100 basis points, compared with 45 bps for triple-A GC, traders said, although one said the market was very volatile.

EXCESS LIQUIDITY

Banks took 195 billion euros in one-week loans from the ECB on Tuesday, compared with 183 million euros maturing, and 56 billion euros of one-month loans compared with 60 billion euros maturing.

Both amounts were similar to the median forecasts in a Reuters poll.

Analysts said those operations will result in excess liquidity of over 230 billion euros next week, seen as high enough to keep the overnight Eonia rate fixings following the same pattern as October's -- settling at about 20 basis points above the ECB's 50 bps deposit facility rate.

"This is our base case scenario, but risks are skewed to the upside as a worsening of the market situation could increase the 'differentiation' among banks in the overnight unsecured liquidity market, thereby fuelling upward pressure on Eonia," Maraffino said.

The ECB holds its one-week and three-month unlimited dollar operations on Wednesday. The last three-month dollar tender in October saw low demand, reflecting the high cost of borrowing with the ECB which is around 110 basis points.

Three-month dollars can be found in the cross currency basis swap market for 105 basis points.

"As this operation is relatively expensive for most market participants, we expect take-up to remain low," said Elaine Lin, interest rate strategist at Morgan Stanley.