David Prosser: For more lending to business, we need more banks

The banks regard yesterday's Project Merlin update from the Bank of England as vindication of their insistence that they have been lending to business. The Bank's decision to publish its own "trends in lending" data simultaneously suggests it does not entirely share that analysis. But whichever side you believe, it is clear that many small businesses still regard themselves as struggling to get credit – we hear such tales every single day.

One reason is that there are now fewer banks operating in the UK than before the credit crunch. Even if our biggest banks had returned to their pre-crisis levels of lending, there would still be a shortage of credit, because lenders from the US, from Scandinavia and from the rest of Europe all pulled out of the UK in the months following the crisis. They have not returned.

This is partly why the Government is so keen to see greater competition in the banking sector. It is not just consumers who need a better deal from their banks – Britain's businesses, particularly small and medium enterprises (SMEs) need a wider pool of funds to tap for lending.

Unfortunately, new entrants to the banking sector are few and far between. That is not to say there have been none, but compared with the scale of the capacity withdrawn from the UK, they are insignificant.

There may yet be bigger fish joining the pool. Virgin Money and NBNK, for example, are circling assets such as Northern Rock and the branches that Lloyds has been ordered to sell by the European Commission. Then there is Tesco Bank, which has been promising a full-scale launch, including mortgages, for what seems like ages.

All three might provide a boost to the funds available to credit-starved businesses. But remember that every bank, new entrant or long-established lender, has to comply with the prevailing regulation – such as the increase in capital banks are being told to hold against assets such as lending. That regulation is already constraining credit supply and will become more problematic as more demanding capital requirements are introduced.

Andy Haldane, the Bank of England's executive director for financial stability, said yesterday that this was an example of how regulators should use new macro-prudential powers. Like others, he wants to see capital rules relaxed during stressed times for the economy, in order to improve the supply of credit.

We have yet to hear, however, how that concept will be incorporated into the powers of the new regulatory bodies the UK is in the process of setting up. Many in the banking community cannot envisage a situation when City regulators would ever beprepared to relax the rules.