George Osborne and Vince Cable anxious that rationing of lending to small businesses could reverse recovery from recession but banks claim there is no demand for credit

George Osborne and Vince Cable will spell out next week the dangers of a double-dip recession caused by a drying up of bank lending to Britain's hard-pressed small and medium-sized businesses.

A green paper, to be rushed out by the chancellor and business secretary before next week's parliamentary recess, will acknowledge the scale of the lending rationing crisis, which could "abort" the fragile recovery.

As the Bank of England (BoE) published data showing yet another month when more loans had been repaid than had been granted, Cable admitted the level of anxiety in the government about the flow of funds to smaller companies. He said: "The green paper will acknowledge the scale of the problem and how the recovery could be aborted if we don't get on top of this.

"There is a fundamental policy conflict between efforts to make the banks safer and our wish to get them lending more freely to promote growth," Cable said.

He has been presented with research from the banks – which have given the work by PricewaterhouseCoopers the name "Project Oak" – showing that tougher capital rules and the end of emergency liquidity injections from the BoE could drain the banking system by £1 trillion in the coming years.

Cable believes there is a "very frustrating standoff" between the banks and small businesses: banks argue there is no demand, while businesses say they are not applying for loans because they expect to be rejected or the cost is too high.

"We have to acknowledge there is an issue," said Cable. Even so, he does not appear to be ready to alter the current lending targets for Royal Bank of Scotland and Lloyds Banking Group, which run until next March.

Since the 2008 banking crisis, lending figures from the banks compiled by the BoE have been positive in only three months. The Liberal Democrats calculated that £46bn of loans had been withdrawn in the past year alone.

Howard Archer, economist at IHS Global Insight, agreed with Cable that the BoE data showed "several worrying traits". Archer said: "The survey very much maintains concern that tight credit conditions could hold back the recovery. This is even allowing for the fact that ongoing muted bank lending to companies is being influenced significantly by low demand for credit in addition to restricted supply.

"Lack of access to credit for smaller businesses is still a serious problem despite some reports that it has risen slightly in recent months," said Archer.

The low level of activity in the mortgage market – where June's 48,000 approvals were the lowest since May 2009 – also prompted Archer to forecast that house prices would fall by 3% to 5% over the second half of the year.

Banks are determined to press their case that the problem is a lack of demand of credit. Stephen Hester, chief executive of RBS, has argued that 74p of every £1 lent to businesses before the banking crisis was to the property sector as a way to try to explain the downturn in lending.

The British Bankers' Association also argues that the behaviour of customers, whether businesses or households, is entirely logical. A BBA spokesman said: "The Bank of England's figures concur with our own: they show that bank customers are responding to the downturn by using their deposits to pay off loans. This is exactly the pattern we would expect to see in downturns. In the meantime, bank lending to individuals and small businesses is governed principally by demand, which reduced during the recession but which now shows signs of stabilising."

Lord Oakeshott, Liberal Democrat Treasury spokesman, stressed the coalition's commitment to tackling the problem. "The banks inflicted a savage £46bn squeeze on British business in Labour's last year in office … getting them lending again to boost growth and jobs is a top priority for the coalition," he said.

Even as the issue of getting credit flowing around the system was being discussed by the government, anxiety over the outcome of Europe-wide stress tests on 91 crucial banks and financial firms was driving the rate at which banks lend to each higher to their highest levels in more than year. The rate to borrow in euros measured by the London Interbank Offered Rate hit levels last seen in August of 0.81125.

The results of the stress tests are to be published after the markets close on Friday, giving any banks that need to raise extra capital the weekend to do so. The four banks tested by the Financial Services Authority – Barclays, RBS, Lloyds and HSBC – are not thought to need more cash to withstand any deterioration in the European economy or the onset of a sovereign debt crisis.