Restoring the flow of bank lending to businesses and consumers must be a more urgent priority for the Chancellor in the fight to combat the recession, the Organisation for Economic Co-operation and Development told Britain yesterday (see Commentary, facing page).

Boosting lending is vital to reviving growth as credit conditions remain extremely tight and “continue to have a substantial negative impact on activity”, the OECD warned in its latest in-depth survey of the UK. “It is essential that the supply of new lending is not held back any longer by banks with insufficient capital to meet losses associated with past lending.”

While the Paris-based think-tank found that radical action by the Treasury and Bank of England “should promote a recovery by 2010”, it said that “this will depend critically on whether measures to stabilise the financial system are effective”. Its warning came as the Bank of England reported that mortgage lending growth fell to a record low in May and was at levels a tenth of those a year earlier. Corporate lending continued to contract.

Yesterday’s report follows the OECD’s stark forecasts last week that the recession will be deeper and longer than Alistair Darling has so far predicted, with the fallout triggering at least a doubling of Britain’s national debt to 90 per cent of GDP next year.

While the OECD expects the recession to end this year, it projects that GDP will slump by 4.3 per cent, while in 2010 it projects that Britain will endure a bout of stagnation, with zero growth rather than enjoy renewed expansion as the Chancellor is betting.

Yesterday’s report hints that the Government may be forced to resort to more radical measures to unclog lending. Measures taken so far to recapitalise banks and ring-fence “toxic assets” remain appropriate, it found.

But the OECD told ministers that they may have to go further. “Where institutions are unlikely to be viable, even with substantial assistance, other measures might be required to restore the health and stability of the financial system without undue cost to the taxpayer,” it said.

It hinted that banks that continue to malfunction might have to face fresh sanctions, including seizure by the Government under new statutory emergency powers recently created.

“The new Special Resolution Regime provides several options for such banks including transferring ownership, a special administration procedure for banks, and temporary public ownership,” the OECD notes.

By contrast John Kingman, the chief executive of UK Financial Investments, the body created to run the Government’s stakes in the partnationalised banks, told a conference yesterday that he was confident of a “gradual exit” by the Government from its role in the banking sector.

With recovery predicted to be weak and elusive, the OECD report said that Mr Darling could be forced to resort to more tax cuts or spending measures to boost activity. But it cautioned that any moves would need to be coupled with “a comprehensive plan to rein back debt to a prudent level”.

The OECD called for both the Bank and Financial Services Authority to shake up their operations. It said that the FSA must devote more resources to policing big banks. It added that senior FSA management must be more engaged in overseeing big banks.

Fears as foreigners sell gilts, page 41

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