High street banks could require another £110 billion in taxpayers’ money to shore up their finances if they are to resume normal lending to consumers and businesses, a leading think-tank says today.

The warning that the banks could need three times as much in public support as the £37 billion already pumped into them will fuel speculation that the Treasury may yet resort to wholesale nationalisation of the banking industry.

The National Institute of Economic and Social Research cautions that a continued squeeze on lending by fearful banks that are hoarding capital could force the Chancellor to make further interventions.

Alistair Darling is expected to use today’s Pre-Budget Report to step up pressure on the banks to ease the flow of credit to struggling businesses. He is also expected to offer direct assistance to 4.7 million small businesses, possibly by imposing restrictions on loan rates.

The warning from the institute will fuel suggestions that the Treasury plans to maintain pressure on the banks by threatening the “nuclear option” of full nationalisation if they fail to ease borrowing conditions.

Speculation that this option remains on ministers’ agenda was stoked by John McFall, the chairman of the Commons Treasury Committee, who is close to Gordon Brown and Mr Darling. He said that if the banks did not play ball, and resume lending, “then the demand for full-scale nationalisation may well grow”.

Pressure on the Government to do more to compel the banks to boost the flow of credit to business is also stepped up today by the CBI. In a letter to the Prime Minister, Richard Lambert, the Director-General of the CBI, calls for urgent action.

“The biggest threat hanging over businesses is cashflow. If they cannot get their hands on the cash and credit they need to go about their day-to-day business, there is a real risk that we could see healthy firms going under,” he writes.

“The next six months will be critical.

If we are to stand a fighting chance of preventing this recession from becoming longer and more painful, we need to act now to get the credit markets working properly.”

His call comes after Bank of England figures showed last week that the growth of lending to households and nonfinancial businesses fell in September to an annual rate of only 6.8 per cent, the lowest since 1998.

In its latest forecasts for Britain’s economy, the National Institute of Economic and Social Research says: “Recapitalising the banking system with 10 per cent of GDP (about £150 billion) would probably ease many of the credit constraints that households and firms currently face and shorten the crisis.”

The institute has downgraded its forecasts of Britain’s prospects, and now projects that the economy will shrink next year by 1.5 per cent in a recession that it says will inflict a “permanent scar” of lost output. It forecasts that unemployment will climb to 2.5 million by 2011.

The institute throws its weight behind the tax cuts and higher public spending that are expected to be announced by the Chancellor today. It suggests that a combination of income tax rebates, and holidays for businesses from paying staff national insurance contributions, would be most effective in rekindling growth.

However, it also says that a fiscal stimulus will be effective only if other countries follow suit. Otherwise, much of the benefit will leak out of the economy to other nations as the extra demand leads to a rise in imports.

The Chancellor’s expected fiscal stimulus scheme is also backed today by the EEF, the manufacturers’ organisation. It calls for a £30 billion package of tax cuts and spending “to prevent the recession turning into a rout”.

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