By Matt Scuffham
LONDON (Reuters) - Royal Bank of Scotland (RBS) <RBS.L> has commissioned a review of its lending to small businesses, responding to concerns of a shortage of finance in a sector seen as vital to Britain's economic revival.
Britain's government and central bank are concerned that poor access to finance for smaller firms may thwart a sustainable recovery from the country's worst slump in decades.
Business lending has fallen despite the government's flagship Funding for Lending (FLS) scheme, which gives banks cheap funding to encourage them to offer credit.
Banks say they must balance demand to lend against the need to avoid the kind of reckless lending which resulted in Britain having to pump a combined 66 billion pounds ($100 billion) into RBS and Lloyds during the 2008 financial crisis.
RBS has come under particular political pressure because it is Britain's biggest small business lender and the government controls 81 percent of it.
The bank said it had appointed former Bank of England deputy governor Andrew Large and management consultants Oliver Wyman to conduct the review. It said the study would focus on what steps it could take to support small businesses and Britain's economic recovery while maintaining sound practices.
"Demand for lending remains a challenge, but we want to do more than just wait for demand to materialize," said Chris Sullivan, RBS's head of UK corporate banking. "We want to play our part in securing the recovery."
RBS's plans coincided with the Bank of England saying Britain's improved economic outlook had boosted demand for corporate credit in the second quarter. The availability of corporate credit, however, was expected to stay little changed.
The central bank said this week that lending to smaller firms dropped by 452 million pounds ($685.71 million) in May and deputy governor Andrew Bailey told lawmakers the desire of British banks to offer credit was still in question.
"The answer they give is, they are increasing their capacity to make lending, and my answer to that is, that's good but I think the jury is very much out on this. I mean, we have to see the evidence on this," he said.
However, banks' assertion that they must avoid reckless lending was underlined by data from the Bank of England on Wednesday which showed a significant rise in default rates on small business loans in the second quarter.
The Bank of England had previously reported a 300 million pound fall in net lending by banks and building societies taking part in the FLS scheme in the first three months of 2013.
Stephen Hester, ousted as RBS chief executive last month, said in May the bank had 20 billion pounds of spare cash it was desperate to lend, but could not find takers because businesses lacked confidence in the British economy.
Last month, the bank said it had identified thousands of British companies it could offer 1.7 billion pounds ($2.6 billion) of extra credit to.
The Federation of Small Businesses said the RBS review should focus on helping small businesses better understand what information they needed to give when applying for credit. For example, it should direct businesses seeking credit to its sector-specific advice.
The British Chambers of Commerce called on other big lenders to follow RBS's lead.
($1 = 0.6592 British pounds)
(Editing by Pravin Char)