UPDATE 2-Flagship British scheme fails to boost bank lending
* BoE says lending expected to pick up in rest of 2013
* Net lending down 2.3 bln pounds since scheme began
* RBS, Santander continue to cut lending
* Nationwide, Lloyds, Virgin Money, Barclays biggest lenders
By Matt Scuffham
LONDON, Sept 2 (Reuters) - Britain's flagship scheme to encourage banks to pump more credit into the economy failed to boost lending in its first year, data showed, as banks focused on meeting tougher capital demands from regulators instead.
However banks using the scheme expect lending to individuals and businesses to pick up over the rest of this year as economic conditions start to improve, the Bank of England said on Monday.
The government launched the Funding for Lending Scheme (FLS) in July 2012 as part of its efforts to lift the economy out of recession.
Under the scheme, the central bank makes cheap funds available to banks and building societies on the condition they lend it on to UK households and businesses.
But despite 41 lenders accessing 17.6 billion pounds ($27.2 billion), net lending - the difference between money lent and loans repaid - fell by 2.3 billion in the year to the end of June 2013.
Britain's biggest banks have cut back on lending and shed assets to meet tough rules on capital imposed by regulators, to prevent a repeat of the 2008 financial crisis. Banks have also pointed to a lack of demand from borrowers.
However, lending grew in the second quarter of 2013, the central bank said, an indication that the FLS is starting to have an impact as the economy shows signs of recovery and the appetite for borrowing improves.
Britain's economy sped up in the second quarter although it remained smaller than before the financial crisis. A survey on Monday showed UK manufacturing accelerated in August, a sign the country's recovery was broadening.
Banks using the FLS scheme lent 1.6 billion pounds ($2.5 billion) in the second quarter, but the improvement was not enough to make up for a decline of 3.9 billion pounds in the previous three quarters.
The Bank of England said net lending to individuals had picked up slightly in the second quarter but lending to businesses shrank.
"FLS participants collectively expect net lending volumes to pick up over the remainder of this year," Paul Fisher, the central bank's executive director for markets, said on Monday.
The scheme runs until January 2015, the year of Britain's next parliamentary election.
The biggest net lenders during the second quarter were Nationwide, Lloyds Banking Group, Virgin Money and Barclays, according to Bank of England data.
State-backed Royal Bank of Scotland and Spain's Santander continued to significantly cut net lending, however. Santander cut lending by 10.4 billion pounds in the last year and RBS by 6.8 billion.
RBS has shed 900 million pounds of assets to reduce risk and make the bank safer following a 45 billion pound government bailout in 2008. Santander wants to lend more to businesses, which requires greater capital to be held, and is cutting back on mortgage lending to enable it to do so.
The British Bankers Association, a industry lobby group, said the scheme had helped to lower the cost of borrowing enabling business to benefit from some of the lowest rates in history. However, the Federation of Small Businesses said small firms were missing out on the cheap finance with many not even knowing about the scheme.
"Many small businesses have been affected by the lack of access to financial support during the financial recovery and have relied on non-bank lenders to keep them afloat," it said.
Lloyds Banking Group, which is Britain's biggest retail bank and is 41 percent owned by the government, returned to positive lending in the second quarter, with net lending of 1.3 billion pounds. Building society Nationwide was the biggest net lender at 2.3 billion pounds.
The Bank of England in June ordered Barclays and Nationwide to improve their leverage ratios, which could have the unintended consequence of slowing their lending. They each lent more than 7 billion pounds net in the last year, over three times more than the next biggest lender.