* Nikkei off lows as some banks up on short-covering
* Trade cautious on policy uncertainty, before 5-day weekend
* Aiful shadows financials after news it seeks debt reprieve
By Elaine Lies
TOKYO, Sept 18 (Reuters) - Japan's Nikkei stock average slipped 0.7 percent on Friday, with financials hit after consumer finance firm Aiful Corp said it was asking for debt repayments to be rescheduled.
But large banks such as Mitsubishi UFJ Financial Group turned positive in later trade, buoyed by short-covering after sliding all week on worries about financial policy under Japan's new government and ahead of public holidays next week.
The new government's minister for banking, Shizuka Kamei, said this week he would like to introduce a moratorium on some loan repayments to help small and midsized businesses and individuals struggling from the economic downturn, sending bank shares lower.
But comments from Finance Minister Hirohisa Fujii on Friday that hinted at scepticism about such a plan helped investors take heart, market players said.
"Bank shares were really hit by political risk this week, after those comments by Kamei, and what we saw today was a bit of position adjustment ahead of the weekend, helped out by the finance minister," said Masayoshi Okamoto, head of dealing at Jujiya Securities.
"It's not really as if anything's been settled, after all."
Overall though, trade was cautious ahead of a five-day holiday in Japan from Sept. 19-23 and after the Nikkei finished above its 25-day moving average the previous day, analysts said.
"A lot of investors are adjusting their positions, with both profit-taking and short-covering emerging depending on individual shares and how they have behaved recently," said Hiroaki Osakabe, a fund manager at Chibagin Asset Management.
The benchmark Nikkei pared its losses to 73.26 points or 10,370.54 after falling as much as 1.4 percent during the morning, and was down 0.7 percent on the week.
The broader Topix ended flat at 939.44. FINANCIALS SHADOWED
"The Aiful news came as a slight shock ... and added to uncertainty in the sector that already existed about the new government's policies," said Kenichi Hirano, operating office at Tachibana Securities.
Aiful was untraded and ended the day at 134 yen, down 27.2 percent from Thursday's close after saying it would ask creditors to push back repayments on about $3 billion in debt as it faces difficulty raising funds and plans for more restructuring.
Rival lenders fell sharply, though some managed to pare losses by the close.
Takefuji Corp lost 9.5 percent and Promise Co Ltd fell 0.8 percent to 599 yen.
Shares in Sumitomo Trust and Banking Co, one of Aiful's main creditors, edged up 0.2 percent to 478 yen, though those of fellow creditor Aozora bank lost 0.7 percent to 134 yen.
Large banks rose in later trade, with Mitsubishi UFJ Financial Group surging 2.5 percent to 529 yen. It was still down 3.1 percent on the week.
No. 3 bank Sumitomo Mitsui Financial Group rose 2.1 percent to 3,430 yen and Mizuho Financial Group gained 1 percent to 194 yen. They were down 7.5 percent and 4.9 percent on the week, respectively.
Chip-linked exporters slid, with TDK Corp down 2.4 percent to 5,640 yen and Kyocera Corp down 0.9 percent to 8,080 yen. Tokyo Electron lost 1.8 percent to 5,580.
But a few reversed course from the morning with Advantest Corp climbing 0.6 percent to 2,425 yen.
So-called defensive shares, such as railways, gained as investors sought out stocks likely to be unaffected by overseas moves during the long weekend, Jujiya's Okamoto said.
Japanese retail investor sentiment towards domestic stocks slid in September from a month earlier, as a stronger yen increased concerns about the outlook for the nation's export-led economy, a Reuters survey showed on Friday.
Trade picked up on the Tokyo exchange's first section, with 2.3 billion shares changing hands, compared with last week's daily average of 2 billion.
Declining stocks outnumbered advancing ones, 953 to 583. (Additional reporting by Aiko Hayashi; Editing by Joseph Radford)