Dexia loaned 1.5 billion euros ($2.07 billion) of fresh capital to its two largest institutional shareholders which then used the cash to buy Dexia shares before 2008, the Financial Times reported on Friday.

The newspaper said that Dexia Bank Belgium, a wholly owned subsidiary of the listed Dexia entity that was seeking funds, loaned Holding Communal, an arm of Belgium's powerful municipalities, 1.2 billion euros which was largely used to participate in two Dexia capital increases in 2006 and 2008.

While, Arco, which invests on behalf of a Belgian trade union, borrowed 275 million purely for the cash calls, according to the FT.

The two parties jointly owned 35 percent of Dexia shares, and continue to be represented on its board, the FT said.

The funding move by the stricken Franco-Belgian lender, that has been at the center of recent market turmoil, amounted to it effectively borrowing money from itself to finance a capital increase.

In a further twist, the FT reported that Dexia accepted its own shares as collateral for the loans. The arrangement meant that any falls in the bank's share price left it potentially nursing large losses.

Dexia's market capitalization has fallen from 21 billion euros in 2006 to about 1 billion euros today.

The FT said the funding move raised the Belgian regulators' concerns at the time, but although it is illegal in most jurisdictions and is now banned in the EU, Dexia did not break Belgium's existing laws.

(Reporting by Stephen Mangan; Editing by Richard Chang)