Many small firms are finding it harder to borrow money

A lack of liquidity means banks are being more selective over who they loaned money to, the Federation of Small Businesses (FSB) says.

Those who could get loans now faced paying interest rates in excess of 10%, it added.

The credit crunch follows a surge in UK interest rates to 5.75%.

Banks often see small businesses as more of a risk Matthew Knowles FSB

"The issue is that the banks are being more choosy over who they lend money to until they ride out the storm," said FSB spokesman Matthew Knowles.

"There's a bit of a 'Computer Says No' mentality. Banks often see small businesses as more of a risk - and because they aren't able to tick all the boxes which the banks set out, they struggle to borrow."

'Staying small'

The FSB said that some of its members were borrowing at between 10% and 11% - more than two percentage points above the rates they had previously been able to get.

Last week, the rate at which banks lend to each other - known as the London Interbank Offered Rate or Libor - hit its highest level for three-month lending since December 1998.

Analysts say that this implies that banks are reluctant to lend money - and that where they will offer a loan - it will be at higher interest levels.

It could be a rocky road ahead David Frost British Chamber of Commerce

The FSB, which represents about 210,000 UK firms, added that there was a broader concern that small businesses would not be able to afford to expand.

"This is a big worry," Mr Knowles said. "A large majority of start-ups are not going on to employ one or two people, which is what we need to see to bring about a reduction in unemployment."

Bank approach

David Frost, director general of the British Chamber of Commerce, said his major concern was a potential slowdown in demand from larger companies for the services and goods of smaller suppliers.

"If bigger firms find borrowing is to be more expensive or that they are unable to borrow, then they may well decide not to go ahead with investment or at least to defer it," he said.

"If this happens, inevitably the smaller firms who fit the units or supply the computers are going to be impacted."

Our lending criteria is based on a number of factors, competitive pricing and the customer's ability to repay being paramount Natwest

He added it was too early to see what the impact was going to be.

"It could be a rocky road ahead," Mr Frost said.

A spokesman for NatWest, one of the biggest business lenders, said that recent market conditions had not changed its approach.

"Our lending criteria is based on a number of factors, competitive pricing and the customer's ability to repay being paramount," he said.

"These are consistent principles and remain unchanged by recent market conditions. Any lending decision is made on a case by case basis."

The credit crunch has followed woes in the US sub-prime mortgage sector, which specialises in loans to people with poor credit histories or on low incomes.