Anger as banks are urged to raise extra £25bn by Bank of England

BoE on defensive as critics say chasing new capital will undermine economic recovery

The Bank of England yesterday drew fire from critics, including the Business Secretary, Vince Cable, for jeopardising Britain's brittle recovery after calling on banks to raise an extra £25bn by the end of this year.

Although lower than earlier estimates of a £60bn funding shortfall, the Financial Policy Committee's decree was attacked for threatening the flow of loans to credit-starved businesses. The Governor, Sir Mervyn King, was forced on to the defensive after Mr Cable hit out at the FPC's stance. "The idea that banks should be forced to raise new capital during a period of recession is an erroneous one. This FPC exercise will prolong the time it takes for the British economy to recover by further depressing already-weak SME lending," he told Sky News.

The CBI also warned over the extra pressure on banks. Matthew Fell, the competitive markets director, said: "While the FPC wants banks to meet additional capital levels in a way that will not restrict lending, it is difficult to see how this can be achieved in practice."

The FPC said the extra money was needed to weather the impact of exposures to the struggling property sector, the eurozone crisis and scandals such as Libor fixing and the mis-selling of payment protection insurance while maintaining lending in the real economy. It wants banks to achieve a tier one capital ratio – a key measure of balance sheet strength – of 7 per cent by the end of 2013, although it declined to name individual institutions which need to raise funds.

James Barty, head of financial policy at the right-leaning Policy Exchange think-tank, said: "Increasing capital ratios even further would lead to a further lack of credit to small businesses. Sir Mervyn appears to hold the belief that if only the banks had more capital, they would lend more. Yet the opposite is the case. It is the Bank's drive to raise capital ratios that is holding back lending."

The Governor said: "Today's recommendations will support lending and promote growth. A weak banking system does not expand lending. The better-capitalised banks are the ones expanding lending, and it is the weaker capitalised banks that are contracting lending." He also said that the capital shortfall identified by the FPC was "perfectly manageable", and taxpayers will not need to stump up any more cash, having already footed the bill for bailouts of the state-backed lenders Royal Bank of Scotland and Lloyds Banking Group.

Andrew Bailey, head of the Prudential Regulation Authority, which answers to the FPC and formally comes into being next week, said banks already had plans to raise at least half the £25bn shortfall.

But Michael Symonds, an analyst at Daiwa Capital Markets Europe, said: "The short time-frame for making good on the £25bn capital shortfall surely represents the most significant challenge. While the Bank might implore banks to raise fresh capital, dispose of non-core businesses and make further cuts to dividends and remuneration, it is virtually inconceivable there will be no clandestine deleveraging.".