Britain's banking industry needs sweeping changes so that it can better support small and medium-sized firms, and would benefit from more middle-sized banks which would be natural lenders to the sector, a top Bank of England official said on Thursday.

The lack of lending to smaller businesses was one of the main drags on Britain's economy, Andrew Haldane, executive director for financial stability at the Bank, said.

It needs structural reconfiguration of the banking industry to ensure that SMEs have the financing they need to be tomorrow's growth, Haldane said in speech to a business conference.

Haldane is a member of the central bank's newly established Financial Policy Committee, in charge of macro-prudential regulation, but is not a member of the Monetary Policy Committee that decides on interest rates.

The government is trying to address the lack of lending to smaller firms with a loan guarantee scheme, which the Chancellor George Osborne plans to present with his 2012 budget next month.

Longer-term changes to Britain's banking landscape were needed too, as its current shape did not suit customers as well as it should, Haldane said.

We have a small number of very large banks and a quite large number of small banks and a missing middle, he said. It is the missing middle of medium-sized banks that would be the natural lenders to you (small businesses).

The government has set out on sweeping regulatory reforms of the banking sector, requiring banks to ring-fence their retail operations from riskier investment banking, as well as trying to boost competition.

Haldane warned that neither businesses nor households had dealt with the debt they piled up in the run-up to the financial crisis.

We are not yet remotely in a position where balance sheets have been fully repaired, he said. Households and business were therefore likely to keep saving and continue to act as a drag on the economy, he added.

He also reiterated the central bank's growth and inflation forecast, noting that falling inflation should help boost consumption.

Real incomes have been squeezed very significantly, more significantly than at any time since the great depression, he said.

The expected improvement in real income in the wake of easing inflation was a key reason why the central bank predicted a pick-up in spending and economic output over the next few years.

(Reporting by Sven Egenter; Editing by Susan Fenton)