By William Schomberg and David Milliken
LONDON (Reuters) - Britain sought to inject new life into the country's stagnant economy on Wednesday by giving banks greater incentives to lend to small and medium-sized firms which complain they are starved of credit.
The Bank of England and the Treasury said a new phase of their flagship Funding for Lending Scheme would be heavily skewed towards smaller firms.
Banks taking part in the programme will also now be able to lend to alternative providers of credit - such as leasing firms which often work with small companies - as well as mortgage and housing credit corporations.
Under a third change, banks can get funding from the FLS for an extra year until the end of January 2015.
The Bank and the government see a lack of credit to small businesses as a major factor behind Britain's very slow recovery from the financial crisis. On Thursday, data could show the economy slipped into its third recession in under five years
Chancellor George Osborne is under pressure to boost growth after concerns from the International Monetary Fund - previously a supporter of his austerity policies - said he may need to slow the pace of spending cuts.
He announced measures to boost the housing market in March and employers groups welcomed Wednesday's changes to the FLS. But they said it remained to be seen whether banks would become less risk-averse and lend to such borrowers as start-up firms.
"What a lot of SMEs (small and medium-sized enterprises) will be looking for is money actually getting to the front line on reasonable terms, and not just to the safe bets," said Adam Marshall, policy director at the British Chambers of Commerce.
Economists said the changes were not a game-changer for the economy. "The FLS is likely to provide a boost when confidence returns to the economy, but confidence is the elusive factor," analysts at Barclays said in a note to clients.
Alan Clarke, an economist at Scotiabank said the changes were probably a complement to more broad-based stimulus in the future by the Bank, and were unlikely to stop it from buying more government bonds later in the year.
INCENTIVES TO LEND TO SMALL FIRMS NOW
The original FLS was launched last August and offers banks cheap credit if they increase lending to households and businesses. Results have been mixed, with benefits so far mainly going to banks and homebuyers rather than small businesses.
Banks drew 14 billion pounds in cheap funding from the Bank between August and the end of last year but the FLS failed to stop a decline in overall bank loans at the end of 2012, adding to pressure on the government to take more action.
The Bank Governor Mervyn King said the extension of the FLS would assure banks about their cheap funding rates.
"This innovative extension will now do even more for small and medium-sized businesses so that they can play their full part in creating new jobs," Osborne said in a statement.
One of the changes announced on Wednesday seeks to get credit to small and medium-sized firms flowing as soon as possible: for every pound of additional lending by banks to the sector in the remainder of 2013, the amount of funding that banks will be able to draw upon increases by 10 pounds.
In 2014, that falls to five pounds of FLS funding for banks for every pound they lend to SMEs.
Lending to other sectors will count on a one-for-one basis towards the allowance for banks accessing the scheme.
Cormac Leech, a banking analyst at Liberum Capital, said the 10-to-1 ratio to increase bank lending to small firms this year would help banks such as Royal Bank of Scotland and Lloyds, which are Britain's biggest business lenders.
"They are highly incentivised to write SME loans even at an underwriting loss. So it's a key positive for them and should help to drive their share price and sector earnings," he said.
Employers groups want more competition in Britain's banking sector as a way to spur fresh lending. Those hopes suffered a blow on Wednesday when the planned sale of 630 bank branches by Lloyds to the Co-Operative Group fell through.
(Editing by Jeremy Gaunt)