The Bank of England has ordered banks to hold billions of pounds more in their “rainy day” funds after the economic outlook “deteriorated materially”, restricting their ability to lend to consumers and businesses.

Its Financial Policy Committee warned of “tentative signs” of a clampdown by banks on mortgage lending and borrowing by businesses most squeezed by the cost of living crunch and supply chain woes.

The Bank moved to rebuild banks’ “rainy day” fund by ordering them to increase the countercyclical capital buffer from 1pc to 2pc by next summer, locking up billions of pounds more in a move that is likely to restrict lending.

Increasing the cash buffer to 2pc would mean banks holding back approximately £22bn of capital. The buffer was released during the pandemic to support lending but the Bank is now ordering lenders to rebuild their back up funds.

The FPC said in its twice-yearly financial stability report that “banks are likely to manage prudently their lending activity” in response to a darkening economic backdrop. But it warned them against an “excessive” credit crunch that would be “counterproductive” by hurting the economy.

The Bank judged that lenders are prepared to cope with the downturn and that tightening lending “to reflect the new risk environment is appropriate”.

Rapid interest rate rises to tame inflation are set to put pressure on households and businesses that have borrowed large amounts following the Covid debt binge.

While loans issued under government Covid schemes have low rates and are less exposed, the Bank estimates that 70pc of the current stock of debt taken on by small and medium-sized firms was outside the programmes. It said a “large proportion” is exposed to rapid interest rate rises by the Bank within a year.

The highest inflation in 40 years, climbing borrowing costs and supply chain disruptions will squeeze firms in the hardest hit industries.

The Bank said there will be “some business failures”, particularly in sectors exposed to high energy costs, including manufacturing and transport, and industries vulnerable to a slump in household spending.

“The economic outlook for the UK and globally has deteriorated materially,” the FPC said.

“These higher prices, weaker growth and tighter financing conditions will make it harder for households and businesses to repay or refinance debt. Given this, we expect households and businesses to become more stretched over coming months. They will also be more vulnerable to further shocks.”

Source: Telegraph.co.uk