The Co-operative Bank is to stop lending to new corporate customers as it seeks to repair a major hole in its finances - dealing a blow to efforts to ease the borrowing squeeze on small businesses.
The move comes after credit ratings agency Moody's downgraded the Co-op to junk status, forcing it to issue a statement that it did not need to be rescued by the taxpayer.
It is seeking to rebuild its capital strength amid reports that it is facing a £1 billion shortfall, with regulators forcing banks to hold more cash as a buffer against future crises.
The bank has begun trying to shore up its finances by disposing of assets such as its life and general insurance businesses. It also pulled out of a deal to buy more than 600 Lloyds banking branches.
Today it emerged that it had gone a step further by stopping its lending to new corporate customers for the rest of 2013. Loans for existing business clients would be considered on a "case-by-case basis". It was not made clear whether this meant they would face tighter lending criteria than in the past. The move does not affect retail customers.
The Co-op has 100,000 small and medium enterprise (SME) customers. Loans to these customers totalled £1.3 billion last year, representing 1-2% of the market share.
It is a setback for policymakers in the Treasury and the Bank of England, especially after the flagship Funding for Lending scheme designed to ease credit conditions was beefed up recently to encourage SMEs to access finance more easily.
But while the scheme incentivises banks by giving them access to cheaper funds to lend on in the marketplace, they must still be able to assure regulators that they have enough capital to be able to make the loans.
It means that those with not enough funds, such as the Co-op, are unable to take advantage fully and help lending grow.
The bank has been dragged down by its 2009 rescue of Britannia, then Britain's second-biggest building society. It inherited toxic commercial property and home loans that dragged it to losses of £662 million in 2012.
It is reported to be in talks with City watchdog the Prudential Regulation Authority about splitting itself into a good bank and bad bank, with toxic assets hived off from the healthy business.
The bank is part of the wider Co-operative group, which has interests ranging from food to funerals. Founded in 1863, it has more than six million members and employs more than 100,000 people.