Soft treatment of "zombie companies" does little harm -central bank
* Banks allow 6 pct of small firms to breach loan terms
* Firms kept alive 40 pct less productive than competitors
* But these firms leave only small dent in UK productivity
* Bond market access helps firms invest without bank help
LONDON, Dec 20 (Reuters) - Softer loan terms for the struggling British businesses often dubbed 'zombie companies' are not a major reason for a big shortfall in UK economic productivity, the Bank of England said on Friday.
Japan's 'lost decade' of stagnant economic growth in the 1990s was widely blamed on banks' unwillingness to pull the plug on unviable companies, which stopped more profitable firms from growing; some analysts fear a similar trend in Britain.
A much smaller share of British firms have gone bankrupt since the financial crisis than after its last recession in the early 1990s, and the BoE is concerned that productivity in Britain is much weaker than in other advanced economies, which could cause higher inflation in future.
Research published by the central bank on Friday showed that British banks had overlooked breaches of loan terms by 6 percent of small firms, whose borrowing accounted for 14 percent of outstanding small business loans as of March.
However, the BoE said the impact on both economic productivity and the stability of Britain's banking system seemed modest.
"Overall, bank forbearance to SMEs (small and medium enterprises) appears to account for only a small proportion of the weakness in aggregate UK productivity," the BoE said.
"Low interest rates are likely to have been more important in explaining higher firm survival rates over recent years ... highlighting vulnerabilities to a rise in interest rates if (it is) not accompanied by an improvement in economic conditions."
British private-sector productivity is 18 percent lower than if it had improved in line with its pre-crisis trend, but only around 1 percentage point of this can be easily attributed to loan forbearance, the BoE said.
Although firms benefiting from bank forbearance were on average 40 percent less productive than other small businesses, they were too few to have a big impact. Two-thirds of firms benefiting from forbearance had a long-term future, banks said.
Forbearance was most common for hotels, restaurants and construction firms, and usually took the form of allowing extended repayment periods and breaches to loan conditions such as debt-to-income covenants, rather than direct payment relief.
BoE chief economist Spencer Dale said last week that another reason for weak productivity might be a more general unwillingness among firms to borrow from banks after harsh treatment during the financial crisis.
Royal Bank of Scotland is conducting an inquiry into allegations that it deliberately forced clients facing temporary financial difficulties into administration so that it could acquire their assets cheaply.
Separate BoE research also published on Friday showed that companies that had been able to raise money from bond markets between 2010 and 2012 had invested more than firms that relied on banks.
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