For Dan Scarfe, an IT entrepreneur in Windsor, times have never been better. In the past few months his software firm Dot Net Solutions, which helps businesses save money by making their IT systems more efficient, has been overwhelmed with requests from companies looking to cut costs in the face of the looming recession.

To deal with the spike in demand, Scarfe applied to the government-backed Small Firms Loan Guarantee (SFLG) scheme for a £100,000 loan for new staff and marketing.

Relative to the four-year-old firm’s £1m annual turnover, it wasn’t an outlandish sum. Barclays disagreed.

Scarfe received his rejection via e-mail. His business fell “outside the SFLG qualification”, he was told.

The bank’s rejection letter added: “Yourself and Dot Net Solutions are very much the type of people/business that we want to do business with and would like to keep in touch with for the future. It would be good to have a meeting next year to see if there is anything that Barclays can do for you then.”

It was the fourth time that Scarfe had been refused a loan request via the SFLG, a scheme conceived to help businesses just like his.

Under the programme, the government offers to take on most of the default risk, guaranteeing three-quarters of the requested funds. Its stated goal is to fill the “funding gap” for small businesses that are otherwise seen as too risky for banks to take on themselves.

Yet for Scarfe, it has done little good. He has now given up trying to raise money from the banks.

“We get a lot busier in hard times and we think we can double our business in the next 12 months, but it is absolutely impossible to get bank funding,” he said. “The SFLG scheme is a complete nonsense. The government shoulders 75% of the risk yet they are not prepared to take any gamble whatsoever.”

Scarfe’s story is not an isolated one. Like many of the UK’s 4.7m small and medium-sized enterprises (SMEs), he is at the sharp end of a contraction in bank lending that shows no signs of easing despite government pressure.

In recent weeks, business leaders and MPs have been shocked by the violence and pace of the contraction. They have been inundated by calls from panicked constituents who have seen trading at their small firms fall off a cliff.

Revenues have plummeted, the phones have stopped ringing. SMEs, the engine room of the country’s economy, are shuddering to a halt.

Banks are making it worse, they say, pushing them to the brink by jacking up interest rates and fees, cutting overdraft facilities and rejecting requests for new loans. A delegation of business leaders to No 10 last week told Gordon Brown and the chancellor, Alistair Darling, that urgent action needed to be taken.

The government has listened. When Darling unveils his prebudget report tomorrow, at its heart will be a raft of radical measures designed to get the blood pumping through the SME system.

The multi-billion-pound rescue package will push the government accounts further into the red – borrowing could rise to £120 billion over the next two years. However, Brown clearly sees that as the lesser of two evils. The prime minister is warning this weekend that if the government does not act now, the country will “pay later”. The message was clear: at all costs, the SME sector must be kept from collapsing.

The aid package is expected to combine tax breaks, an increase of the cash available through the SFLG, earlier payments on government contracts, greater access to credit insurance and overdraft facilities, and other measures that are still being hammered out this weekend. Whether the cocktail of measures will be enough to get money flowing again is still unclear.

The fear is that the business sector is following the same trajectory that mortgage lending has taken, down nearly 50% on a year ago. For the UK economy, that would be a disaster.

SMEs make up just under half of the UK’s gross domestic product and employ more than 13m people. A systemic strangulation would exaggerate what is expected to be a painful recession that could put up to 3m people out of work.

Since the government churned £37 billion into the banks last month, and put several hundred million more on reserve at their disposal, Darling has been exhorting them to keep their side of the bargain and turn on the taps.

Bank chiefs argue that they are continuing to lend but are just being more choosy about whom they give money to, and on what terms. This week the industry will launch a robust defence against the growing chorus of critics.

Royal Bank of Scotland, the biggest lender to SMEs with more than a quarter of the market, will today announce a “price promise” capping rates on overdraft facilities and will also pledge not to withdraw committed facilities for at least 12 months.

It has created a new division of 500 advisers who specialise in dealing with economic downturns, that it will deploy around the country to help clients deal with the recession.

It is not all that surprising. Last week John McFall, chairman of the Treasury committee, threatened the “nuclear option” and accused banks of failing in their responsibility to society. He said: “The demand for full-scale nationalisation may well grow.”

His public threat echoes the anger being vented behind closed doors by Darling and Brown at banking chiefs amid a drumbeat of reports from companies being hit by higher fees, onerous interest rates, or being turned down for new loans.

The panic is such that struggling companies are often too scared to come to their bank for help. “At the moment, businesses are scared stiff that if they go to the banks for money they will have them over a barrel,” said Douglas McWilliams, chief executive of the Centre for Economics and Business Research.

“Typically, banks are now charging between three and four times what they were charging two or three years ago. Companies don’t want to be put into the hands of people who will screw you badly.”

In its favour, the government has a big stick to hit the banks with thanks to its partial ownership of several of them. Threats alone won’t be enough. A range of options, some more draconian than others, are being discussed by government. One idea is the appointment of a banking supremo to make sure that banks are lending at the levels and terms they should.

Another plan expected to feature is a beefing-up of the role of regional development agencies (RDAs), which could take £4 billion in funds from the European Investment Bank destined for the banks and instead funnel it directly through to businesses. High-ranking politicians in both major parties believe RDAs have failed to deliver much for business and it is felt their local presence may produce quicker and better solutions than those emanating from Whitehall.

The agencies may well be charged with reskilling workers who lose their jobs and arranging “crisis loans” of up to £250,000 for businesses on the brink of collapse.

“If ever there was time for regional development agencies to deliver something, now is it,” said John Cridland, deputy director-general of the CBI. An increase of the amount available via the SFLG and a cap on the interest rates charged is expected to be part of the package.

Credit insurance is also critical. In recent weeks insurance providers have reportedly withdrawn cover from thousands of suppliers, which take out insurance to protect against nonpayment if a retailer they supply goes out of business.

Without credit insurance, suppliers may demand upfront payment for goods, or not provide them at all, raising the spectre of stores with half-stocked shelves in the run-up to the critical Christmas period.

Lord Mandelson, the business secretary, has spent the past week with the biggest credit insurers to keep them from withdrawing from the market.

Businesses need all the help they can get. Nick Bate, UK economist at Merrill Lynch, last week revised his outlook for the economy, predicting it would contract by 1.6% in 2009 after previously predicting a shrinkage of 0.2%. UK unemployment, he forecast, would top out at about 8% of the work-force, or 2.5m people, by 2010.

The banks argue they are being unfairly demonised. The British Bankers’ Association maintains that lending to businesses has increased.

It released figures last week showing that lending to businesses was up by 10% to £44.8 billion in the year to September, while overdraft borrowing grew by 4% to £9.3 billion.

Phil Orford, chief executive of the Forum for Private Business (FPB), said the figures did not cover the most acute part of the downturn. Since October 9, the banks have pulled back from the market, increasing fees on overdraft facilities, rejecting new loans, and raising interest rates as they try to rebuild their balance sheets.

The effects of the Bank of England’s 1.5% interest-rate cut to 3% earlier this month have yet to trickle through.

The industry has begun to react. RBS’s pledge on pricing and availability of overdraft facilities address a key crunch point for its 1.1m business customers: a sharp reduction in short-term cash flow.

“It’s an area we’re very much focused on. For some businesses it has become very tight. But the last thing we want to do is terminate a good business that is simply having short-term cash issues,” said Peter Ibbetson, head of small business at RBS. “We’re committed to helping them through this if we can. Our objective is to come out of this working with the same SMEs that we’re working with now.”

Lloyds TSB will launch its own defence tomorrow, high-lighting double-digit growth in its lending to small business and its role as one of the biggest providers of new mortgages.

Corporate tax cuts are also on the cards. The business leaders who met Brown and Darling proposed rolling back the corporate tax rate to 20%. David Frost, director-general of the British Chambers of Commerce, said: “Small businesses need help – and at a time when rates for big business are falling it’s unfair that small firms should be paying more.”

Since 2006 the tax rate has risen from 19% to 21% and is set to tick up to 22% next April.

For some, Darling’s push has come too late.

Andy Halpin, former owner of Devon-based builders’ merchant Payne Timber, put his firm into administration last month after he was unable to find a bank to lend £150,000 to save a firm with a £7m turnover. The company had been hit hard by the housing downturn and its lender, Royal Bank of Scotland, reduced its invoice-discounting facility.

“Invoice discounting in a rising market is great fun but in a falling market it is a nightmare,” Halpin said.

“When business started dropping away we did not have the invoice sales to borrow against. We were doing 50% of our target borrowing, but the invoice-discounting facility was reduced by much more, from £500,000 to £150,000.

“They said we didn’t have enough capital to borrow against.”

The company’s failure has left 50 people out of work.

Halpin said: “A couple of years ago if I had walked into my bank manager’s office and asked for £200,000 he would have said what account do you want it in? As soon as they stopped making a profit from us they dropped us.”

The FPB recently formed an economic downturn panel comprised of members who report back on a biweekly basis on availability and terms of finance. The initial results bear little resemblance to the rosy outlook painted by the British Bankers’ Association and the rest of the industry.

Nearly half the respondents reported an increase in banking fees since September, and 43% said loan availability was worse than expected. Only 6% were satisfied with the government’s response to the crisis.

Orford said: “The big issue is availability of short-term cash flow for small businesses. Despite a number of high-level meetings on this, so far there has been no clear signal that the banks are looking strategically to the issues that we are seeing day in and day out.”

There were other worrying findings. According to the panel, business owners are taking ever greater risks to keep their businesses afloat. In many cases, they are having to put up personal assets, such as their homes, as collateral to get bank financing.

“We have evidence that banks are taking the easy route out and using personal securities for collateral. It’s cheaper for them because they don’t have to put valuers into businesses to value their assets, their property and look in depth at the books,” Orford said.

David DeVere, co-founder of Bates Wharf Marine Sales, a Surrey boat seller, hopes he doesn’t have to go to that extreme. He has seen a 15% drop in business from last year and is bracing himself for worse in 2009.

He has been forced to slash inventory at the 17-year-old firm because the companies he relies on to finance his purchasing, GE Commercial Distribution Finance and HBOS, have drastically cut back on funding.

“HBOS has ground to a halt, there is no other way to describe it,” DeVere said. Worse, the handful of boat-financing specialists, which include divisions of RBS and Barclays, have in some cases doubled the deposit they require for boat buyers and hiked interest rates.

“We’re getting hit from both ends, on retail finance and stock finance,” he said.

Furthermore, the weak pound has eroded most of his margin because he imports his stock from America and Italy. “I think we can ride this out for 18 months. But if this lasts more than six or eight months, I think a lot of companies are going to have real problems. The government needs to take measures that will help business. Simple as that.”

The week the crisis went global

IT was the week when even the optimists realised that the global economy’s winning streak had come abruptly to a halt, writes James Ashton. In Macau, the former Portuguese colony that aspires to be the Las Vegas of Asia, building work fell silent. On the Cotai strip, three half-finished towers were deserted by thousands of laid-off construction workers, many of them immigrants drafted in to cope with now diminishing demand.

As they streamed off the site, local gaming tycoon Stanley Ho, one of the main beneficiaries of the tourism boom, warned a recession could last for up to three years. Like business leaders across the globe, he knows there are only troubled times ahead, as equities plummet, interest rates sink and jobless queues lengthen.

Grim outlook

Some 1,300 miles away in Beijing, the picture was no different. State officials shared Ho’s prognosis, describing China’s employment outlook as “grim”.

Yin Weimin, the minister for human resources, extinguished hopes that emerging economies could remain immune from the global financial crisis. He revealed what sacked factory workers already knew - that unemployment in China’s cities had begun to rise and would increase further next year.

Writing in a Communist party magazine, Wen Jiabao, the Chinese premier, borrowed heavily from the language of every other concerned world leader. He said: “We must be crystal clear that without a certain pace of economic growth, there will be difficulties with employment, fiscal revenues and social development.”

To stimulate growth, the Beijing government approved a £373 billion package to pay for the construction of roads, railways and other infrastructure. Yet China’s hope of keeping economic growth as high as 8% is a pipe dream to western economies that are gripped by fear of recession and deflation.

Retail pain

In the United States, new jobless claims climbed 27,000 to 542,000, 10% above predictions and the highest level since July 1992. Unemployment stands above 4m, the highest level for 26 years.

Thousands more are expected to lose their jobs in Detroit and surrounding towns, even if America’s carmaking giants - General Motors, Ford and Chrysler - succeed in persuading Congress to hand over $25 billion to stave off bankruptcy.

This Friday is known as Black Friday in the US, the start of the annual Christmas shopping season. The day after Thursday’s Thanksgiving holiday is one of the biggest shopping days of the year - and one that retailers hope will pull their accounts out of the red and into the black. The early signs are not good. Shoppers have deserted retailing, from high-end clothing to DIY.

Last week Saks, the swanky department store chain, announced it had lost $42.8m (£29m) in the three months to November 1, compared with a profit of $21.6m for the same period a year ago. “Clearly our customer doesn’t feel wealthy,” said Stephen Sadove, Saks’ chairman and chief executive. Home Depot, the DIY chain, and electronics giant Best Buy are also reeling. What is becoming clear is that the global economy is at a tipping point.

Cash stimulus

Around the world, fund managers are braced for earnings forecasts being slashed, reduced dividends and belt-tightening across the board.

In the UK, the FTSE 100 slumped 10.7% last week on fears that the worst is still to come. House repossessions are on the rise, up 12% quarter on quarter. Analysts fear the spectre is looming of forced sales by cash-strapped buy-to-let mortgage customers.

In the US, only the news that Barack Obama had picked Tim Geithner to be his Treasury secretary helped shares bounce back from 11-year lows. The scramble by investors to safer assets pushed yields on two-year Treasury bonds, an indication of where investors think the US Federal Reserve will set interest rates over the next 24 months, below 1% to their lowest level since the invention of the two-year bond in 1976. British bond yields hit their lowest since the second world war.

Russian premier Vladimir Putin unveiled a $20 billion stimulus package and urged Russians not to panic after wage arrears rose sharply. Iceland borrowed $10 billion, roughly equal to a year’s gross domestic product, from a combination of the International Monetary Fund and various European governments.

President Nicolas Sarkozy earmarked €20 billion (£17 billion) for a new state investment fund to protect France’s strategic industrial assets from the credit crunch or foreign takeover. Analysts at Banca Leonardo, an investment bank, claim Italy’s top 10 banks require a combined €21 billion to bring their financial strength into line with their European competitors.

“What the world still needs now is a substantial, sharp Keynesian fiscal stimulus on an orchestrated basis,” said Sir Martin Sorrell, the chief executive of advertising giant WPP. “What’s happened so far is still not sufficient.”

It may take more than a roll of the dice by panicked finance ministers to reverse what is a global decline.

Additional reporting by Matthew Goodman, Kate Walsh and Ben Marlow

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