By David Milliken
LONDON (Reuters) - Britain will slowly phase out a scheme to support small business lending over the next two years rather than halt it at the start of next year, the Bank of England and the finance ministry said on Monday.
The news comes a day before the Bank releases a major report, which some analysts expect to usher in tighter rules for other type of lending while the central bank waits for the economy as a whole to be ready for higher interest rates.
The central bank said the Funding for Lending Scheme (FLS), which started in 2012 with a focus on mortgage lending, would be extended for another two years as credit conditions for small businesses had not improved enough.
But lenders' access to cheap finance for new lending to small businesses will be steadily restricted from January, in order to remove wholly support for new finance by January 2018.
"The Funding for Lending Scheme will be gradually wound down as the recovery strengthens, delivering a managed exit from the scheme," Chancellor George Osborne said.
Support for mortgage lending was withdrawn in early 2014.
British banks are lending to consumers at the fastest rate since before the crisis, and large firms have easy access to funds through capital markets, but bank lending to small businesses remains limited.
BoE figures released earlier on Monday showed that in the year to October, small business lending grew by just 0.7 percent compared with 2.4 percent growth in mortgage lending and an 8.2 percent increase in unsecured consumer credit.
"Conditions still remain relatively tight. So it is important that the support provided by the FLS is withdrawn gradually," BoE Governor Mark Carney said in a letter to Osborne.
The Bank said its Monetary Policy Committee judged the decision would not affect the timing of a future interest rate rise, and that its Financial Policy Committee -- which will issue the half-yearly report on Tuesday -- welcomed the move.
Banks taking part in the FLS lent a net 1.1 billion pounds to small and medium-sized businesses in the first six months of 2015, in contrast to a net reduction in lending of nearly 2 billion pounds last year.
The biggest net lenders to small-and-medium enterprises during the period were Lloyds Banking Group (L:LLOY) and newer rival Aldermore (L:ALD), the data showed.
But some small businesses still mistrust banks, after they abruptly withdrew funding during the financial crisis. The BoE has said poor access to credit was one reason why British productivity remained weak for years after the financial crisis, a situation which is only gradually starting to improve.