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Could British Business Bank Solve UK Economy’s Problems?

The notion of a new U.K. state-backed bank targeting lending to small businesses has gained more currency in recent days.

Steve Allen | Photodisc | Getty Images

Given the general lack of affection towards the banking sector shown by many U.K. politicians, now might seem like an odd time to promote a new bank. (Read More: What Can Be Done to Fix U.K. Banks’ Reputations?)

Yet the U.K. government is on a charm offensive following a high-profile shake-up. Prime Minister David Cameron is expected to announce reforms to planning law designed to kick-start construction activity on Thursday. (Read More:Cameron to Unveil Planning Reforms)

There is also increasing focus on the problem of lending to small businesses, many of whom seem to be put off by the cost of lending. Smaller businesses are seen as key to restoring growth to an economy mired in recession, which shrank by 0.5 percent last quarter, but several government schemes have tried and failed to stimulate lending.

The profusion of schemes could itself be confusing to businesses which don’t have a huge accounts team. And more indirect ways of stimulating lending, like the mass liquidity injection provided by the quantitative easing program, have failed to halt a decline in borrowing by small businesses.

Only 43 percent of small and medium-sized enterprises (SMEs) used external finance in the second quarter, down from 51 percent in the previous quarter, according to BDRC Continental's quarterly SME Finance Monitor. A third of SME loan applications and a fifth of those that applied for overdrafts were turned down, according to the report.

Chancellor of the Exchequer George Osborne spoke at the weekend of an “alphabet soup” of existing schemes like Project Merlin or the Funding for Lending scheme. (Read More: Why UK Voters are Dumping Osborne)

“A small business bank could make a real step forward if it helped small businesses find their way in via a one stop shop. At the moment, all the different schemes are confusing,” John Cridland, director-general of the CBI, the British business trade body, told CNBC. (Read More:John Cridland on UK Reshuffle)

The British Chambers of Commerce has championed the idea.

David Kern, chief economist at the British Chambers of Commerce, said in a statement: “To boost growth, there must be a revival in business lending. The MPC and the government have to play their part by using the existing QE program more effectively, and by exploring measures other than QE on its own.

“The UK’s growth prospects would improve dramatically if the government was to act quickly on the support shown by the Chancellor at the weekend for the creation of a fully-fledged British Business Bank.”

There are concerns that banks should not be encouraged to lend to businesses which are bad bets, particularly after the harsh lessons of the credit crisis. (Read More: What UK Banks Can Do to Fix Their Reputations)

“The reality is, we are not going to turn the clock back to 2007. Now we know that debt got us into trouble, and banks know that they can’t do the kind of lending they did in the past. We’ve just got to make the best of the situation we have now,” Cridland said.

“Banks need to operate for the real economy, but we also need sources of finance like private equity, like insurers, like pension funds, sovereign wealth funds, because banks can no longer do the heavy lifting.”

Written by Catherine Boyle, CNBC. Twitter: @catboyle01.

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