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George Osborne
Chancellor George Osborne hopes his changes to FLS will be enough to grow business lending and the economy again (Reuters)

Funding for Lending has been given a significant makeover by the Treasury and Bank of England so the scheme is more focused on improving credit conditions for small and medium-sized enterprises in a bid to reverse the on-going decline in business lending.

FLS has been extended by a year to last until January 2015, has had its incentives increased for lenders to provide more credit to smaller firms, and will now also be open to some non-bank lenders.

The scheme has been criticised amid falling bank lending to SMEs - which tumbled by £4.8bn in the three months to February - and because it has only brought down mortgage costs, not the affordability of business credit.

"This is a big boost for small and medium sized businesses that are at the heart of the British economy," said Chancellor George Osborne in a statement.

"FLS has already reduced the costs of household mortgages and loans for businesses. This innovative extension will now do even more for small and medium sized businesses so that they can play their full part in creating new jobs."

Under FLS, banks are able to access discount loans from the BoE to a value linked to their stock lending to the real economy of consumers and SMEs. As a bank increases its lending to the real economy, so does the amount of cheap money it can access from the BoE.

At the moment this is at a ratio of 1:1, so for every pound extra lending they can borrow a pound at an advantageous rate, better than that at which they could borrow in the inter-bank market.

However, the changes announced by the Treasury now mean that for every pound a bank increases its lending specifically to SMEs in 2014 it can access five times that in discount borrowing from the BoE. For the rest of 2013, this ratio is even better at 1:10.

FLS will also be extended to include non-bank lenders - such as invoice finance houses - owned by banking groups taking part in the scheme. This means the parent banking group will be able to count lending to SMEs by its non-bank arms in its total when calculating how much they can borrow at the cheap rate.

"The additional incentives for banks should accelerate activity in the small business financing market," said Matthew Fell, Confederation of British Industry (CBI) Director for Competitive Markets

"But we need to be realistic - Funding for Lending is only one piece of the finance jigsaw. Boosting firms' confidence by raising awareness of the various funding schemes available is critical."

The Treasury is hoping that this will bring life back into the comatose UK economy, which has had a number of growth forecasts slashed amid weak domestic output and an uncertain outlook.
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