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Alistair Darling and Lord Mandelson are insisting on extra lending to Britain's small businesses as the price for putting more taxpayers' money at risk in the banking system.
High-street banks are urging the chancellor and the business secretary to extend the special liquidity scheme (SLS), which was rushed in after the collapse of Bear Stearns in April to stop the banking system collapsing, or introduce other measures to help unfreeze the moribund money markets on which they relied for financing before the credit crunch.
Acting on the recommendation by the former HBOS chief executive Sir James Crosby to allow £100bn of taxpayers' money to guarantee mortgage-backed securities is thought to be high on their wish list. Mortgage-backed bonds package up mortgages that are sold on to investors. They provided £200bn of finance for banks last year, before the credit crunch paralysed this wholesale market for funding, which allowed banks to lend out £700bn more than they held in deposits.
The possibility of guaranteeing other loans, such as those to credit cards, small business loans and even personal loans, is also being debated.
The haircut - the fee charged by the Bank of England to exchange illiquid mortgage bonds for more attractive government paper - could also be reduced to make the facilities more cost-effective.
Amid heightened dialogue between the banks and the government, a range of matters are being discussed. The chancellor is making clear that banks will need to demonstrate that taxpayers are getting something in return for the £500bn already put at risk through the £37bn share stakes, the SLS and other liquidity schemes.
At the core of the ongoing funding crisis is the stubbornly high rates at which banks lend to each other. This rate, known as Libor, is about 3.5%, considerably above the 2% to which the Bank of England cut its rate last week.
Lloyds TSB blamed Libor yesterday for driving up the rates on its new tracker mortgages. The move by Lloyds, which is expected to be more than 40% owned by the taxpayer after its takeover of HBOS next year, came as the fully nationalised Northern Rock passed only half of the one percentage point cut to its customers. There was a one and half percentage point reduction on its savings rates.
Lenders' policies towards homeowners and small businesses are regarded as vital as the economic crisis worsens. It is thought that there is some consideration over giving Northern Rock a beefed-up role, while Mandelson's small business finance forum met yesterday to hammer out a new "statement of principles" for the way banks treat small businesses, including making it easier for them to switch between banks.
Private-sector solutions are also being drawn up. M&G, the fund management arm of Prudential, is talking to other institutional investors about setting up a fund to provide long-term funding to UK companies "with stable cash flows who face the challenge of accessing finance from banks who are shrinking their balance sheets".
Banks are also trying to pre-empt government action by making pledges not to withdraw small business overdrafts or raise interest rates. HSBC, which is not taking taxpayers' funds, this weekend set out targets for lending.
Banking analysts at the Swiss bank UBS urged the government yesterday to adopt the Crosby recommendation, which they believe will "finally address the key problem in the UK - a lack of credit availability despite banking bail-outs". They also noted that "having Northern Rock lend again would reverse the single largest driver of reduced mortgage availability".
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