By Matt Scuffham and David Milliken
LONDON (Reuters) - A flagship Bank of England scheme failed to boost lending to small British businesses in the third quarter although the decline was less marked than earlier in the year.
The Funding for Lending Scheme (FLS) was launched in mid-2012 to provide cheap money to banks on condition that they lend to British businesses and households. It was amended at the start of 2014 to focus on small business lending.
It was an antidote to moves by Britain's biggest banks to cut back on lending and shed assets to meet tougher rules on capital imposed by regulators after the financial crisis.
However, its impact has so far been muted and there are fears that a lack of credit available to small firms could hamper Britain's economic recovery.
Lending to small businesses by banks and other lenders in the scheme dropped 128 million pounds in the three months to the end of September, a smaller fall than earlier in the year and for much of 2013.
Total lending, which included credit to large firms, fell by 2.4 billion pounds. The biggest overall decline came at state-backed Royal Bank of Scotland and Lloyds Banking Group, which have cut back drastically on lending to large firms since their bailouts.
Banks have pointed to a lack of demand from borrowers despite Britain's economic growth.
Two thirds of Britain's smaller companies are aiming to pay off their debt and not borrow more, according to a survey published on Thursday.
Those that are looking to borrow are also turning to alternative lenders with trust in banks eroded by scandals including the mis-selling of interest rate hedging products to small businesses. Larger companies can also tap capital markets for funding.
Net lending by RBS contracted by 1.38 billion pounds, including a 1.2 billion pound drop in lending to large companies and a 165 million reduction in lending to small businesses.
Lloyds' overall net lending contracted by 980 million pounds, incorporating a 1.2 billion pound drop in lending to large companies. However, it was the scheme's biggest provider of credit to small businesses, lending 304 million.
The biggest rise in overall lending came at Santander UK, which lent 332 million pounds to businesses, including 107 million to small businesses.
New bank Aldermore was the third biggest provider of credit to small businesses, lending 73 million.
(Reporting by David Milliken; editing by William Schomberg and Keith Weir)