Image caption Bank governor Sir Mervyn King first announced the new scheme last month

A new scheme to prompt banks and other lenders to make more money available to homeowners and businesses has come into operation.

Under the Funding for Lending initiative, the Bank of England will lend money at below-market rates to the financial institutions.

The Bank will then monitor their progress in lending the cash out.

Some mortgage lenders have already cut the cost of their long-term, fixed-rate deals.

But the lower borrowing costs being introduced by mortgage lenders are so far only being offered to people with large deposits.

Aaron Strutt, at mortgage brokers Trinity Financial, said: "Most deals attractive to first-time buyers, such as those at 90% or 95% loan-to-value, have not changed yet."

The introduction of the new lending scheme comes as the Nationwide building society said house prices had fallen last month for the fourth time in five months.

The decline of 0.7% in July means prices are now 2.6% lower than they were a year ago, at an average of £164,389.

'Quickly proving effective'

According to the Bank of England, the Funding for Lending scheme (FLS) is "designed to incentivise banks and building societies to boost their lending to UK households and non-financial companies".

Under the initiative, the commercial banks will be able to exchange collateral, such as existing loans for pieces of paper known as Treasury bills, on which they will pay an interest rate of 0.25%.

They will then be able to use these bills as backing with which to borrow cash cheaply on the wholesale markets, money they can then lend onto homes and firms.

The programme will supersede the current National Loan Guarantee Scheme.

In the past couple of weeks several of the UK's biggest lenders - NatWest, HSBC, Santander and now the Nationwide - have cut their mortgage rates to below 3% for new, four or five-year, fixed-rate deals.

How the scheme will work Banks and building societies can initially borrow Treasury bills up to 5% of the amount they currently lend

They will be charged just 0.25% interest, much lower than the going rate

They can borrow more than 5%, only if they increase their overall lending

If they decrease lending, the interest rate will increase up to 1.5%

The banks use the Treasury bills as backing to buy money cheaply on the financial markets. It is this money that they then lend out

The Bank of England and taxpayers will be protected from any losses made on the loans agreed by the banks with homes or firms, because the banks will have to provide collateral to the Bank of England of a higher value than the loans

Lending levels to be monitored by the Bank of England

These are the lowest long-term mortgage rates yet seen in the UK, although they are only available to the small minority of borrowers who can put down a 40% deposit.

Ray Boulger of mortgage brokers John Charcol said: "It is already clear that, in stark contrast to Project Merlin [under which the National Loan Guarantee Scheme was introduced], the Funding for Lending Scheme is very quickly proving effective as far as the mortgage market is concerned."

The scheme will ultimately supersede the £20bn National Loan Guarantee Scheme, which was only launched back in March, and will now be allowed to run down.

Labour's shadow Treasury minister Chris Leslie said the winding down of the previous scheme was a blow to Chancellor George Osborne's "dwindling credibility".

"Despite promises from ministers, net lending to businesses has fallen in every month of this government," he added.

"And there are serious questions about whether the new Funding for Lending scheme will really see lending to businesses become cheaper and easier to access."

Hoarding complaints

The purpose of the Bank of England's scheme is not just to inject some life into the moribund property market.

Communication will be key - whatever the name of the scheme - to ensure that businesses actually benefit from it John Walker, Federation of Small Businesses

Its aim is to make cheaper loans available to small and medium-sized firms, outside the financial sector.

They have complained for several years that the banks are hoarding cash rather than lending, even to relatively-safe borrowers.

Official figures show that lending to non-financial firms has indeed been falling, a trend that the Bank of England would like to reverse.

In the past four years the stock of outstanding loans to non-financial companies has shrunk by 17% from its peak, to £420bn in June this year.

Last week the RBS group, which includes NatWest, announced that it would take advantage of the new scheme.

It will cut the interest charges on loans worth £2.5bn, which it expects to make available to small and medium sized businesses.

The interest charge will be cut by an average of one percentage point, the bank said.

'Change needed'

The British Bankers' Association, which represents the UK's banks, said it welcomed the FLS.

It added: "The UK's lending market is very competitive - and with support through schemes like the FLS for even lower cost borrowing, now is a very good time for UK businesses and individuals to speak to a bank about their financing needs."

John Walker, national chairman of the Federation of Small Businesses, said it remained to be seen how successful the new Funding for Lending scheme would be for small firms.

"The main objective for any government-backed scheme should be to ensure that the finance actually gets through to small firms," he said.

"Four in 10 small firms were refused [bank credit] in the second quarter and this needs to change if the economy is to grow.

"Communication will be key - whatever the name of the scheme - to ensure that businesses actually benefit from it."

In other developments concerning the financial sector, the government has launched a consultation on what additional powers authorities may need in the future to deal with any failing non-bank financial institutions, such as investment firms and insurance companies.

The consultation period will close on 24 September.