Chancellor George Osborne today said the launch of an £80 billion emergency scheme to kick start bank lending showed Britain was “not powerless to act” in the face of the eurozone crisis.
The Bank of England and Treasury unveiled their "funding for lending" programme in an attempt to ward off a tightening credit squeeze and help drag Britain out of its double dip recession.
The Bank painted a grim picture for households and businesses today as it warned that credit availability was falling and borrowing costs rising as the eurozone woes take their toll on the banking sector.
But the funding for lending scheme aims to free up the log jam in credit hitting the economy, by offering banks cheap finance on the condition they pass it on to borrowers.
Mr Osborne said: "Today's announcement aims to make mortgages and loans cheaper and more easily available, providing welcome support to businesses that want to expand and families aspiring to own their home.
He added the initiative would "inject new confidence into our financial system and support the flow of credit to where it is needed in the real economy - showing that we are not powerless to act in the face of the eurozone debt storm".
Under the scheme, British banks are being offered funding at low interest rates over a four-year period - but it will be directly linked to bank lending performance to encourage lenders to increase loan availability and reduce rates.
For every £1 of additional lending made by a bank, it will be able to access an extra £1 of cheap funding from the scheme. Those that reduce lending will have to pay higher fees to use the scheme.
Bank of England governor Sir Mervyn King said the scheme created "strong incentives" for banks to increase lending.
He added: "The more banks expand lending, the more they can use the scheme. That will encourage banks to make loans to families and businesses both cheaper and more easily available."
Banks will be able to access finance at rates from around 0.75 per cent including fees - far cheaper than the equivalent 1.25 per cent to 2.5 per cent rate in finance markets.
They will be able to borrow up to 5 per cent of their existing lending stock, which will be increased if they expand net lending over the next 18 months.
The Bank will publish a bank-by-bank breakdown of lending each quarter, which will lay bare the success of the scheme.
It is hoped that first-time buyers and small businesses will benefit the most, as they have been starved of affordable credit.
Experts have warned there are no guarantees the plans will address the core problem of companies reluctant to borrow or see banks lend more even with the carrot of cheaper funding.
The Bank hopes competitive pressure among banks will ease rates and borrowing terms substantially, which in turn would encourage firms to borrow.
The Bank made it clear on launching the scheme that it is designed to support the economy and not the banking industry.
The CBI said the scheme should provide a "real incentive" for banks and building societies to increase their lending to businesses and individuals, if possible at lower rates of interest.
CBI director-general John Cridland said: "It is a positive step towards stabilising funding for lending, particularly given the current market turmoil driven by the eurozone crisis.
"I hope this may enable mortgages to be available at a lower rate of interest."
He added: "Smaller businesses I talk to are concerned with cost of borrowing as well as with its availability. Funding For Lending will help the transition to a 'new normal', where structural changes in banking, driven by capital and liquidity reforms, are impacting on business finance."
Launching the scheme during a visit to crane and hoist manufacturer Street Crane in Chapel-en-le-Frith, Derbyshire, this morning Mr Osborne said: "The British Government and the Bank of England are going to support lending to families who want to buy a home with a cheaper mortgage or businesses like this who want to expand and take people on so we are going to lend money to banks on the condition, and it's going to be a very strict condition, that they lend it on to businesses like this.
"So this is huge help, many billions of pounds of help for the British economy because we've got lots of problems in the world, problems in the eurozone, the slowing economy in China, lots of problems but the British Government can act and will act".
He added: "What we're demonstrating today is that the Bank of England and the British Government can work as a team to help lending in our economy that will bring cheaper mortgages for families, cheaper business loans so they can expand and hire people."
Chris Lindley-Smith, sales director at Street Crane, which employs some 200 people in the Peak District, said: "We were pleased to host the visit of the chancellor today partly in recognition of our efforts in the global export market.
"The announcement made by the Chancellor today is excellent news for small to medium manufacturing businesses which should have a very strong positive effect on our home market sales."
The British Bankers' Association (BBA) threw its support behind the funding for lending scheme.
A BBA spokesman said: "We welcome this initiative, which clearly shows the Government and Bank of England are ready to stand with the financial sector in ensuring the money is available to fuel the recovery."
He added: "This new funding for lending scheme should help insulate new borrowers against the worst effects of the eurozone crisis.
"It is designed to help the flow of credit to customers and should therefore help encourage our economic recovery."
The co-ordinated action is part of a raft of measures being taken to boost lending as banks face a worrying new phase in the credit crisis.
Today's launch comes a week after the Bank announced another £50 billion will be pumped into the economy through its quantitative easing (QE) programme, taking the total offered under QE so far to £375 billion.
Banks are also being told they are free to tap into billions of pounds held on their balance sheets to use for lending, after the Bank of England recommended rules on liquidity reserves should be relaxed.
This followed the launch of the Bank's six-month loan facility programme, with the first £5 billion monthly auction held at the end of June.
Labour Treasury spokesman Chris Leslie said: "With Britain one of only two G20 countries in a double-dip recession, urgent action is needed to stimulate the economy. The Bank of England is now recognising this, but the Chancellor still refuses to acknowledge his plan has failed.
"We hope this new scheme from the Bank of England will be more successful than George Osborne's failed Project Merlin and credit- easing policies, which have seen net lending to businesses fall.
"But it does not go far enough. To address the biggest problems in our economy - a lack of confidence and a lack of demand - we need a change of course from the Government on tax rises and spending cuts which go too far and too fast.
"Only a credible and balanced plan for jobs and growth that gets our economy moving again and people back to work will succeed in getting the deficit down. Without urgent action now Britain will pay a very heavy long-term price."