Bank warns lenders that support will be withdrawn

Building societies and banks could face funding gap of nearly £200bn

The continuing weak flow of credit to the real economy was confirmed in reports yesterday from the Bank of England and the Council of Mortgage Lenders. They were accompanied by a stark warning for the banks and building societies from a senior Bank official that the current generous funding they receive from the Bank will not be renewed, leaving them with a funding gap of nearly £200bn.

The Council of Mortgage Lenders – representing almost every bank, building society and independent broker – said that gross mortgage lending dropped sharply in January to just £9.1bn, a 10-year low.

However, the CML also stressed that much of the fall could be attributed to a bulge in lending during December, as buyers took advantage of the last month of the stamp duty holiday on properties valued at less than £175,000. Lending generally remains at historically low levels, about one-third of pre-crisis figures, suggesting that the current strength in house prices may not be sustainable.

Paul Samter, CML economist, said: "We remain in a period of uncertainty for the housing market and economy at large. The market certainly improved over the second half of last year and started 2010 in better shape than most would have predicted 12 months ago. More recent developments have been influenced by the end of the stamp duty holiday, and are likely to foreshadow a larger than usual seasonal drop-off in activity in the early part of this year.

"However, the Bank of England is likely to keep rates low, which should continue to mitigate mortgage payment problems and help cushion borrowers from the worst of the recession."

An even more difficult situation may face lenders and borrowers as the economy tries to emerge from recession, however. In a speech last night the Bank of England's executive director for markets, Paul Fisher, stated that the bank did not have a mandate or the ability to "provide a source of long-term funding for the commercial banking system" and that it does not "have access to funds that could be used to sustain commercial lending operations."

In relation to the Special Liquidity Scheme (SLS), which has lent more than £180bn to he banks, Mr Fisher reiterated that the SLS will close at the end of January 2012, by which time SLS participants should be funding their balance sheets in the market by other means. His comments echo those of the Governor, Mervyn King last week.

Mr Fisher added that the Bank may continue to step in as "Market Maker of Last Resort", for example in the commercial paper market to "facilitate otherwise credit-worthy firms in maintaining their access to short-term finance".

More widely, the Bank's latest Lending Trends Survey showed that net lending to British businesses weakened in December. In the fourth quarter of last year, the Bank said, the stock of lending to companies fell across all the main sectors of the economy for the third consecutive quarter, and "demand for new corporate borrowing remained weak". Bank lending as a whole was flat in January.

Net consumer credit flows were reported by the major UK lenders to have weakened in January, partly reflecting the bad weather. Underlying demand for consumer credit is subdued and the availability of credit tight. Despite the record low Bank Rate, spreads over Bank Rate and Libor on credit cards and similar debts remained significantly wider than a year ago.