Lending crisis growing as businesses face squeeze

Small firms were the biggest victims of the tightening lending conditions during July, the report revealed, with bigger multinationals able to seek alternative sources of liquidity elsewhere.

Economists said the situation would continue to prohibit economic expansion, adding further credence to the argument for so-called "QE2" - a second wave of printing money.

Earlier this month, the Bank's monetary policy committee (MPC) decided to keep QE on hold at 200 billion but a number of economists have recently made the case for additional stimulus.

Their case was further strengthened yesterday by the publication of the lowest August mortgage lending figures in ten years by the Council of Mortgage Lenders.

Howard Archer, chief UK and European economist at IHS Global Insight, said yesterday's data "very much maintains concern that tight lending conditions are posing a significant obstacle to economic activity".

However, the business lending report, published by the central bank, also revealed that demand for credit remained subdued as firms focused on paying off debts rather than borrowing more money.

In the case of SMEs, critics argue this is because of the prohibitively high cost of finance - a problem that has persisted since the height of the credit crunch.

Colin Borland, public affairs manager for the Federation of Small Businesses in Scotland, said: "It is important to emphasise that any lack of demand for bank lending from small businesses does not mean there is a lack of demand for finance.

"Our members are using a range of alternative finance options - from savings to credit cards - in their businesses. While this may have helped them through the worst of the credit crunch and subsequent recession, it is clearly not a sustainable option."

Borland added that there is a still a trust issue among many small firms, which found their overdrafts withdrawn or interest rates suddenly hiked during the recession.

According to the research, businesses repaid 2.5bn in July, less than the 3.2bn returned in June but still a sign that businesses are focusing on repaying debts rather than borrowing to expand in anticipation of another downturn.

Meanwhile so-called "M4" money supply - bank and building society deposits and cash - fell 0.2 per cent month-on-month in August, taking the annual growth rate down to 1.8 per cent compared to 8 per cent growth prior to the financial crisis.