The government will not extend a deal requiring banks to meet fixed lending targets to businesses, a Treasury source said, scrapping a scheme designed to revive ailing credit markets, which have been a barrier to economic recovery.

Since the 2077/08 financial crisis, many smaller firms unable to raise funds on capital markets have found it hard to borrow to expand, just as the government is looking to the private sector to drive economic growth as it cuts spending.

The government struck a deal with 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.

Data on Friday indicated institutions failed to give enough credit to small companies. The British Bankers' Association defended the sector's commitment to lending, estimating credit flows to small firms of 74.9 billion pounds in 2011.

That fell short of a target of 76 billion pounds for lending to small and medium-sized companies.

The Merlin banks have met their overall business lending commitments, a spokesman for the banks said. This performance demonstrates the banks' commitment to providing businesses with the financial support they need to invest and grow and the significant progress made this year.

The Bank of England will publish the final Project Merlin lending figures at 0930 GMT on Monday.

Lenders are on track to meet their overall target of 190 billion pounds - the BBA said overall lending by the five banks hit 214.9 billion pounds last year - but the sector is likely to come under fire for falling short of its small business target.

Banks need to play their part by continuing to support British business going forward, Financial Secretary to the Treasury Mark Hoban said.

Figures published so far by four of the five banks show credit facilities to SME's in 2011 came in at 63 billion pounds.

The Bank's own data shows that net lending by the Project Merlin banks - HSBC , Barclays , Royal Bank of Scotland , Lloyds Banking Group and Santander - fell by 9.6 billion pounds in 2011.

Part-nationalised Lloyds said on Friday it lent 12.5 billion pounds to SMEs in 2011, ahead of its target of 11.7 billion.

CREDIT EASING

Chancellor George Osborne has already flagged that he doesn't consider lending targets to be a permanent solution, saying that credit easing will help channel money directly to where it is most needed.

Critics of the scheme have argued that the targets are of little use, as they only measure gross lending, not net new lending and gauge only credit facilities made available rather than how much money has actually been lent.

In reality, many small firms have still encountered difficulty getting loans, while banks have blamed the weak economic outlook for crimping credit demand.

Under pressure to find ways to boost Britain's flagging economy, Osborne last year unveiled a separate, 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 he stressed the aim is to get the scheme up and running within a few months.

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 funds that lend directly to medium-sized businesses with a turnover of up to 500 million pounds.

(Additional reporting by Matt Falloon; Editing by John Stonestreet and Susan Fenton)