Plans to free up loan cash revealed

Plans to free up billions of pounds of cash held by banks have been announced to help kick-start lending in the latest attempt to ward off a tightening credit squeeze.

The Bank of England said City regulators should tell banks they can tap into large amounts of cash held on their balance sheets if needed in the face of a worsening eurozone crisis.

The Bank hopes the move will offer a substantial amount of cash to lenders, estimating total liquidity held across Britain's banking system at around £500 billion.

On unveiling the Bank's latest Financial Stability report, Governor Sir Mervyn King said: "Our challenge remains making sure the banks are in the best possible shape to weather the storms they are facing and those that lie ahead so they can support lending to the real economy."

He added: "Banks have built up significant assets in recent years. They are in a strong position to withstand a period of market stress. But it's very important that they are willing to use them in times of stress to support lending to the real economy."

It is the next plank in the Bank's strategy to help Britain's economy recover from its double-dip recession, following the announcement earlier this month of a £100 billion-plus scheme to boost bank lending.

The Bank is working on a new "funding for lending" scheme, while last week it held its first £5 billion monthly auction under a six-month loan facility programme. Sir Mervyn confirmed that UK banks were suffering from higher funding costs as money markets tighten due to the deepening woes in Europe. They have already been passing on half of these increases to borrowers through loan rates, but the Bank warned that credit availability will tighten further if the rises are passed on in full.

The Bank believes that these recommendation to allow banks to make greater use of liquidity cash piles will help ease conditions for borrowers - but it also stressed that it was still vital for banks to build up longer-term capital reserves that protect them in the event of further financial crisis.

Sir Mervyn reiterated calls on banks to rein in bonuses and investor dividends to boost their capital cushions. He said four out of five of the UK's biggest banks had already reined in their cash bonuses, but more needed to be done.

It is hoped the moves to relax liquidity buffers will allow banks to make better use of the cash boost offered under the Bank of England's £325 billion Quantitative Easing (QE) programme. The Bank is widely predicted to extend QE in the coming months and minutes of the June rates meeting revealed four of the nine-strong committee - including Sir Mervyn - were narrowly outvoted on more QE, although fears remain that there are no guarantees the Bank's raft of measures will persuade banks to lend or recession-hit companies to borrow.