On the 1st of March David Ruffley questioned Mervyn King, the Governor of the Bank of England on the Bank of England's february 2011 report on inflation.

Q30 Mr Ruffley: Governor, Project Merlin has seen an agreement with the big four banks and the Government for them to lend in 2011 £190 billion in gross new lending, and I understand that the Bank will be monitoring that. Could you just explain whether or not you are worried about the absence of a net measure, because that £190 billion is gross? IsnÕt that something that might cause difficulty for SMEs, if quite a lot of that £190 billion does not take account of repayments?

Mervyn King: Let me make it clear we were not involved in the discussions on Project Merlin at all.

Mr Ruffley: But you are monitoring the £190 billion.

Mervyn King: WeÕre not monitoring. What we are doing is putting up on our website the data that banks submit after a fairly cursory plausibility check. We are not auditing the data that are submitted; we are monitoring and in a light sense. We are putting up on our website the data of the banks involved in the Project Merlin agreement, which involves the figures that they collectively in total for that group of banks describe as gross lending. Alongside that, we will also publish the Bank of EnglandÕs numbers for gross lending, which is a different definition, and we will also be publishing the figures for net lending according to our definition, so that you will be able to see the three different variables that have been produced.

Q31 Mr Ruffley: In basic terms, what are the main differences around the two definitions that differ from the BankÕs?

Mervyn King: As I understand it, the Project Merlin definition includes facilities. That is money that companies could borrow but have not yet borrowed, and our definition would include only loans that had been made-facilities versus actual lending. There is the difference between the two measures of gross lending, and of course then there is net lending, which at present to the corporate sector as a whole from the banking sector is negative. But you will see all three numbers go up, and we plan to put up the first set of data I think towards the end of May, which is when the first set of numbers would appear.

Q32 Mr Ruffley: Is it conceivable that the Project Merlin numbers see £190 billion in 2011 being hit, but on your measures it will not be hit?

Mervyn King: We donÕt have a target for our measure at all. The numbers will be different according to the three series that we publish, and the difference in definitions will explain why they are different.

Q33 Mr Ruffley: Yes. It is quite an important point. I represent a middle England constituency in Bury St Edmunds, which is replete with small and medium-sized enterprise, and they are extremely concerned at the behaviour of the bank up until now and have some hope for Project Merlin delivering. The £190 billion figure in Project Merlin obviously has the rider, "Should sufficient demand materialise." It is a caveat of some significance. What are your regional surveys telling you at the moment of future demand for cash from the SME sector? Does it look as if it is buoyant? Does it look as if there is demand?

Mervyn King: I think there is no doubt that anyone who goes round the country and meets small to medium-sized businesses meets a lot of people who feel that they have been denied access to credit. I just find it very, very hard not to go round the country and get that impression. The figures for actual net lending are very clear. The UK banking sector is supplying a negative volume of net lending to the business sector as a whole and credit conditions have improved for bigger companies, but thereÕs no real sign that theyÕve improved for small to medium-sized companies. I can understand why people running those companies still feel under great pressure.

Q34 Mr Ruffley: I know that this is not your direct responsibility, but you will have a view. On the £190 billion new gross lending figure, would you expect that to be met in 2011?

Mervyn King: I have no idea. I canÕt judge that. We werenÕt involved in the discussions, but I think that what matters is that you will be able to see the figure that the banks have lent according to the Project Merlin definition to see whether they have complied with that agreement or not, and you will also see the Bank of EnglandÕs number for gross lending and our figure for net lending. You will be able to draw your own conclusions as to whether you think the agreement was met and whether the agreement, having been met, has met the ultimate objectives of it. But that is for you to decide.

Mr Ruffley: Sure. I appreciate you telling us that you were not involved in Project Merlin at all, which surprises me somewhat.

Mervyn King: I find it very hard to judge myself as to the link between the two definitions of gross lending. I think we just have to see.

Q35 Mr Ruffley: That was going to be my next question. It is not your responsibility, you have made that very clear and it is very fair of you to point that out, but why wasnÕt the Bank of England definition of gross lending adopted?

Mervyn King: I have no idea. I simply canÕt help on that.

Mr Ruffley: Have you asked the Chancellor why?

Mervyn King: No. It was an agreement reached between the Treasury and the banks. I think a lot of negotiations went on. I donÕt think it is my place to say why they didnÕt reach a different agreement.

Q36 Mr Ruffley: Do you think you should have been consulted on Project Merlin?

Mervyn King: No. I see no reason why we should. This was a matter between Government and the banks and it had a great deal to do with lending and also compensation.

Q37 Mr Ruffley: My final question is that should the £190 billion target for 2011 of new gross lending not be met, obviously that is a matter between the Chancellor and the big four banks-you have made that clear-but if the Chancellor came to you and said, "Well, listen, this lending is not getting out to the SMEs in this country," could you tell him what other measures would be available to the Government to extend credit to SMEs? Are there any other tools in the policy locker? At the end of the day, you are the Governor of the Bank of England, and if there is a problem with the SMEs because of the failure of the big four banks, what would you suggest? What would you advise the Chancellor, or indeed this Committee?

Mervyn King: I can set out some options. They are the same options that I set out for the previous Government, and indeed for this Committee, which is that I think there are only three options. Either you are patient and wait for the banks to get back to a position where their balance sheets are strong enough for them to be able to lower the costs of funding, because one of the constraints on banks is that they canÕt obtain funds themselves except at quite high premiums relative to bank rate. That is one strategy; that is, wait. The second is to use the state ownership in banks to direct them to take a different strategy towards lending. The third is to set up some taxpayer-funded scheme for supplying guarantees to borrowing by small businesses, small enterprises. Those are broadly the three classes of solutions. It is not my place to recommend which of those three is the most appropriate, but those are the three options. They were set out for the previous Government and explained to this Government, and Governments have to make their own judgment then as to what is the right thing to do.