Chancellor George Osborne will not extend the fixed lending targets the government agreed with Britain's major banks last year, as negotiations with lenders on a new credit easing scheme draw to a close, according to a Treasury source.

Many smaller firms that are not able to raise funds on capital markets have found it difficult to borrow to finance investment, forming a major stumbling block to Britain's economic recovery.

The Conservative-led coalition government had struck a deal with Britain's major banks last year to boost lending to businesses, but the Project Merlin scheme was criticised for doing little to alleviate tight lending conditions for firms.

Under pressure to find ways to boost Britain's flagging economy, Osborne last year unveiled a 21 billion pound credit easing scheme which aimed to lower the cost of borrowing for firms by providing government guarantees for banks' funding.

But details of the National Loan Guarantee Scheme, which was supposed to lower the cost of borrowing for small businesses by around 1 percentage point, have been thin on the ground.

Delays have occurred because of disagreements over how to make sure banks pass on the savings in borrowing costs to small firms, and also over how to charge banks for access to the funding, according to the Treasury source, though the aim had been to get the scheme up and running within a few months.

Under the Project Merlin deal struck last February, HSBC, Barclays, Royal Bank of Scotland, Lloyds Banking Group and Santander pledged to make 190 billion pounds of credit available to businesses in 2011, of which 76 billion pounds was to be earmarked for smaller businesses.

However, many small firms still found it very difficult to get loans, while banks blamed the weak economic outlook for crimping credit demand. Osborne had already flagged in November that he would not impose further lending targets on banks.

Last month, the government launched a first phase of the scheme, under which it will invest up to 1 billion pounds alongside private sector investors in investment funds that lend directly to medium-sized businesses with a turnover of up to 500 million pounds.

(Reporting by Fiona Shaikh; Editing by Catherine Evans)