While the Bank of England continues to push on its soggy bit of string, cutting interest rates once again on Thursday, the problem of getting banks to lend more is no nearer to being solved. The howls from corporate Britain suggest that bankers remain reluctant to disgorge new loans or roll over existing ones, however much they insist they are lending more than ever.

One problem, of course, is that in downturns, everyone pays their bills later, so more credit is needed just to stand still. Even if lending has been stepped up, it's not keeping pace with demand and it is being priced more expensively into the bargain.

The ensuing corporate failures are not necessarily a bad thing, when they rid the economy of excess capacity from an era when credit was artificially cheap.

We do need the credit bubble to deflate — just very, very, very slowly and gently.

None of the options for boosting lending are attractive. The recapitalisations of the banks thus far have partly restored confidence in them but they have done little to persuade their managements to relax their stoney lending stance. Yet more capital might help but is politically explosive — probably requiring outright nationalisation in some cases.

Relaxing the penal rate (12 per cent) at which banks are now borrowing from the Government through preference shares has been suggested. But it would provoke fury from those banks, like Barclays paying 14 per cent on its prefs, which opted out of the government rescue offer. Similarly, relaxing the capital rules for banks only weeks after forcing them to raise more capital would not go down well.

Expanding or further relaxing the rules of the Special Liquidity Scheme may help, enabling the banks to exchange more assets for highly liquid government bonds. But this scheme is primarily about boosting liquidity, not lending. Guaranteeing bond issues by banks has helped a little, winning them access to the wholesale markets, but it is seen as expensive.

An alternative wheeze gathering support would be the creation of a so-called “bad bank”, a fund that would take some of the most toxic assets from the banks and keep them ringfenced. This was the original aim of the Tarp in the US, but was eventually discarded. It was used successfully in a previous banking crisis in Sweden and has been adopted by the Swiss National Bank in its rescue of UBS.

It is not alchemy. The banks — or more likely the Government — have to provide the necessary capital to back the bad bank. The bad debts are still there, but they are separated from the banks and so no longer infect their balance sheets. Their presence no longer poisons their lending decisions.

And the long-term philosophy of the bad bank is to hold the toxic waste till maturity, or at least for a good long time. That helps put a floor under the market prices of their unloved assets.

The dumping of all pre-1993 claims into a standalone business, Equitas, helped to stabilise Lloyd's of London a decade ago and could be a blueprint for a similar scheme today for Britain's banks.

As the OECD says today, omitting to remove the bad debts on bank balance sheets before recapitalising them could prove to have been a mistake for the UK. It certainly prolonged the agony in 1990s Japan.

Taxpayers will understandably recoil at the notion of paying yet more to insulate bankers from the consequences of their past greed and recklessness, but not to do so may prove even more costly to the wider economy.

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