Treasury set to offer new guarantees to get banks lending again

Plan will implement Sir James Crosby's proposals. Call for cost of new scheme to be reasonable

A Government guarantee for bonds backed by mortgages and other types of loan is set to be announced by Alistair Darling, the Chancellor. Mr Darling will move to offer Government insurance on behalf of banks wanting to securitise new mortgages, after being told by sector executives that this is the best way to enable them to increase lending to mortgage borrowers. The scheme could be extended to cover loans to small businesses and other debt.

Treasury officials, it is understood, are working on the final detail of the scheme, first proposed in last month's pre-Budget report by Sir James Crosby, the former chairman of Halifax Bank, as a way to encourage lending.

The scheme would be the UK's first serious attempt to kick-start the securitisation market, through which wholesale investment institutions such as money market funds, provide lenders with the finance they need to offer loans not backed by deposits from savers.

The wholesale market, which provided lenders with £650bn of funds in 2007, has almost dried up, amid fears about banks' creditworthiness worldwide. Sir James argued last year that if the Government stood behind British institutions borrowing from the wholesale market, the logjam could be broken.

One senior banking source said the guarantee was now the single most important action the Government could take to encourage lending, which is seen as a crucial policy objective in the bid to stop the UK's economic recession becoming a full-blown depression.

"The official view was that the recapitalisations we saw in the autumn would provide some relief on liquidity," but that was always naïve," he said. "Banks are looking for action on liquidity, where the UK has been slow to act compared to the US and the European Central Bank."

Senior bankers used a lunch date with the Prime Minister yesterday to press home their case for Government action. Eric Daniels, the chief executive of Lloyds TSB, Marcus Agius, the chairman of Barclays Bank, and Mervyn Davies, the chairman of Standard Chartered, were amongst Sunday lunch guests at Chequers.

The lunch was planned months ago, with banking sources last night stressing it was not a meeting called specifically to discuss the lending crisis. However, with Lord Myners, the City Minister, and Mr Darling also present, the Government's plans were high on the agenda of topics for discussion.

Mr Brown will use today's summit on jobs to again stress his determination to increase bank lending. He will tell an audience of business leaders: "My pledge to you is simple: we will act – together with other leaders – to get banks and business back on the move."

However, bankers have warned the Prime Minister that the detail of the new scheme will be crucial to its effectiveness. In particular, they have expressed concern about fees charged in return for government guarantees.

The high cost of the guarantees offered by the Government last year to banks lending to each other, is seen as one reason why that scheme was not widely used. At the end of last year, the Government said it was cutting its charges for banks using this facility.

The new scheme will operate alongside other measures intended to bolster the UK's flow of credit, including an expansion of direct help for small businesses such as the loan guarantee scheme. Ministers are also still considering special help targeted at individual industries, such as car manufacturing.

The next stage in the Government's attempts to deal with the credit crunch and its effects on the real economy may prove only an intermediate plan. The Treasury has said quantitative easing, an expansion of the money supply whereby banks swap illiquid assets for government paper, is not yet on its agenda, but the policy, expected by many economists, has not been ruled out.

Further measures may be necessary to help banks that run into difficulties. This could include another round of recapitalisations, or a return to the "bad bank" idea, in which institutions' problematic assets would be taken off their hands by a state-run banking vehicle.