Lord Mandelson on Friday issued a stern warning to banks against “overreacting” to the prospect of businesses collapsing by withdrawing credit.

The business minister said banks were in some cases “giving in to fear and cutting themselves off from customers who are viable, growing businesses”. The result, he said, was the UK would suffer a worse recession than was otherwise likely.

The comments, in an interview with the Financial Times and a subsequent news conference, are Lord Mandelson’s most critical of banks so far.

There is deep anger among businesses and consumers at a dearth of credit even after the £400bn government bail-out of banks.

The City has sometimes appeared unaware of the damage done to its image by the credit crisis. The minister predicted that the next six difficult months would set the tone of banks’ relationships with business for the next five years.

Lord Mandelson said that “fear is feeding fear” and corroding trust between banks and customers. He told the FT: “The business sector thinks that the banks want to cut them off, and the banks are very worried about the business sector. Where they lack information, they are perhaps over-reacting to what they suspect is going on with order books or viability.”

The peer , brought into the cabinet by Gordon Brown as a recessionary troubleshooter, criticised lenders that “imposed a new funding criteria by edict, by e-mail, in 48 hours”.

He diagnosed faults in the command structure of big banks with “local personnel adopting a low-risk or no-risk approach, which is not necessarily what the [management of the] banks nationally want them to do”.

He warned: “If otherwise profitable, viable companies are simply cut adrift through over-reaction or poor decisions by lenders, that will have severe consequences for the future of our economy.”

Stopping short of suggesting sanctions against banks, Lord Mandelson said it was his responsibility to help them improve their communications with business. He said “future action” on the credit squeeze would depend on the findings of a monitoring panel on lending due to report in a month’s time.

The minister cautioned business leaders against panic job cuts at the end of a week which has tens of thousands of redundancies announced. He hinted that the government might introduce value added tax and national insurance payment holidays for struggling businesses. He was studying a slump in trade credit insurance closely and would consider a response next week.

Lord Mandelson stepped in to rescue Andy Youngman, a Lloyds TSB banker, from semi-ironic heckling at one meeting with businesses in Birmingham. “Leave that man alone,” said the minister. “He’s got a job to do.”

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