The Government moved again to try to ease funding pressures on the banks on Monday by revamping a much-criticised scheme which was designed to help them to recapitalise with private money.

The Treasury intends to reduce dramatically the cost of guarantees that it is offering to help to entice investors to buy bonds issued by Britain's banks.

The so-called credit guarantee scheme is the key to the Government's drive to prop up the banks and impel them to step-up lending, in a development that is seen as crucial to Britain's economic recovery.

The state guarantee of bank bonds is the key to the ability of the banks to raise money from investors and, in turn, to the banks capacity to lend. The Treasury announced yesterday that it would reduce the cost of the debt guarantees by an estimated 25 per cent. They have been criticised for being too expensive to be effective.

By guaranteeing to pay out on the debts covered by the scheme in the event of a default, banks can raise money through the issue of new bonds and other securities far more easily.

However, the banks had to pay for the guarantees and many in the City regarded the fee — which was half a percentage point higher than the market rate for insuring an institution's existing debt — as a punitive rate. The existing rate is thought to translate into more than 100 basis points (1 per cent) for the typical UK bank, compared with an average of about 75 basis points in the US. Treasury sources said yesterday's cut would knock about 25 basis points off the price of the average guarantee, bringing it roughly into line with the US.

The Treasury was responding to fears that without a reduction in the cost of the guarantees, the banks are more likely to seek new capital from the state in addition to the £37 billion injection they have already collectively received from Government coffers.

Speaking after the announcement of the guarantee cuts, Alistair Darling, the Chancellor of the Exchequer, said there were signs that British banks were finally beginning to lend more but that “quite clearly a lot more needs to be done”.

The Government has set aside about £250 billion for its credit guarantee scheme, making it the largest part of the state's £500 billion banking rescue package. The Treasury's decision to cut the cost of debt guarantees came before a grilling by MPs of bank bosses about their lending to small and medium-sized businesses today.

Peter Luff, who chairs the Commons Business and Enterprise Committee, said: “The purpose of our evidence session is to assess the effectiveness of what has been done so far to increase the flow of credit to SMEs [small and medium enterprises] and to identify any further public policy initiatives that could be taken.”

David Frost, director-general of the British Chambers of Commerce, and Andrew Cave, head of policy at the Federation of Small Businesses, are among those giving evidence.

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