REFILE-UPDATE 3-British banks cut lending despite Bank of England largesse
* UK banks using FLS scheme cut net lending in fourth quarter
* Some economists say this boosts case for more QE
* BoE says banks have taken almost 14 bln stg of FLS funds
* BoE and banks blame seasonal factors for fall in lending
* Business minister calls figures "very disappointing"
LONDON, March 4 (Reuters) - The Bank of England's flagship plan to boost lending failed to stop a decline in bank loans late last year, adding to pressure on the central bank to provide alternative economic stimulus.
Britain's Funding for Lending Scheme (FLS) was launched by the central bank and finance ministry last June to aid growth by offering banks cheap funds if they stepped up lending to home-buyers and small and medium-sized businesses.
Monday's data shows that while banks and building societies have drawn down almost 14 billion pounds ($21 billion) of cheap central bank funds, net lending has actually gone into reverse.
Business minister Vince Cable - a Liberal Democrat who favours more government investment than his Conservative coalition partner and finance minister George Osborne - said the figures were "very disappointing" and that he would ask the central bank if the scheme could be improved.
Britain's economy looks increasingly like it may be tipping into its third recession in four years, following very weak construction data earlier on Monday and an unexpected contraction in factory output reported last week.
Borrowers repaid banks and building societies some 2.425 billion pounds more than they lent in the last three months of 2012, turning around a small rise in lending in August and September.
"It is pretty clear that the FLS is not living up to expectations," said Michael Saunders, chief UK economist at Citi. "The limited impact from the FLS raises the likelihood of other forms of easing and additional credit easing in our view."
The central bank will decide on Thursday whether to restart its quantitative easing programme of buying government bonds.
Last month, three officials - including Governor Mervyn King and Paul Fisher, who is in charge of the FLS - favoured buying a further 25 billion pounds of bonds on top of the 375 billion bought between March 2009 and October 2012, while others felt alternative stimulus might be more effective if needed.
If wavering policymakers conclude the FLS is not having the desired effect, this could cause them to back more bond buying. But it is far from certain that they will draw this conclusion.
Although the scheme has not yet succeeded in boosting lending, it has helped markedly reduce banks' borrowing costs, which has in turn fed through to lower interest rates and easier terms and conditions for some borrowers.
The central bank said the fall in lending in the last three months of 2012 was due to seasonal factors. Lending picked up strongly in January, albeit based on data that includes banks such as HSBC which did not join the FLS.
"I would not expect to see a return to rising aggregate quantities until we start getting data for 2013 at the earliest," the BoE's Fisher said.
"It is still quite early for much extra money to have flowed from the application stage into actual loans, compared with previous plans which showed that lending was most likely to fall in aggregate without the FLS."
The British Bankers' Association said demand for lending was muted in the last three months of 2012, citing both a seasonal dip and firms' broader concerns about the economic outlook.
But some economists did see encouraging signs in the scheme data, particularly the fact that almost 10 billion pounds had been drawn down by banks in the last three months of 2012, double the sum in the first two months of the scheme.
"It's not been an overnight surge, but it's moving in the right direction," said Alan Clarke of Scotiabank. "It was a bigger number than I thought would come."
Banks have until the end of this year to draw down funds equivalent to 5 percent of their loan book - roughly 70-80 billion pounds based on current lending - but will face penalty interest charges if they do not maintain or increase lending over the period.
The British Chambers of Commerce, which represents many small firms, said Monday's figures were "disappointing", while the Confederation of British Industry, which represents bigger firms that generally have easier access to credit, said its members were reporting lower finance costs.
The aggregate FLS figures mask wide differences between lenders. Newer entrants to Britain's concentrated banking market, such as Aldermore, Metro Bank and Shawbrook Bank, have increased lending sharply.
But far larger, more established banks such as Royal Bank of Scotland, Santander and Lloyds Banking Group feel under regulatory pressure to reduce much non-core lending, and have cut lending by several billion pounds each.
Bucking this trend among major lenders are Barclays , which has increased net lending by 5.7 billion pounds, and Nationwide Building Society, where lending has risen by 3.6 billion pounds.