Bank of England governor Mervyn King has announced the Bank and Treasury are working together on a ‘funding for lending’ scheme for banks.

Speaking at the annual Mansion House dinner, Mr King said the scheme would work by providing funding to banks for an extended period at rates below current market rates.

The aim of the programme is to cut the rising cost of loans and mortgages and could support up to £80bn in new loans.

The scheme would be linked to the performance of banks in sustaining or expanding their lending to the UK non-financial sector.

He said the ‘black cloud overhead’, referring to the Eurozone crisis, had led today’s higher borrowing rates and bank funding costs.

Mr King said: “The black cloud overhead means that today only very large amounts of capital will attract funding at rates close to those in the past.

“But today’s exceptional circumstances create a case for a temporary bank funding scheme to bridge to calmer times. Such a scheme could prevent an aggregate deleveraging of the banking system that might hold back recovery.”

The scheme could be in place ‘within a few weeks’ and could run for several years.

Commenting on the scheme, Richard Lloyd, executive director of Which? consumer group, said: “While we cautiously welcome the Chancellor’s new ‘funding for lending’ scheme, we want to see clear safeguards in place to ensure that banks pass this cheap credit on through loans to small businesses and to consumers through lower interest rates on their mortgages.

“For too long, banks have taken advantage of the lack of competition on the high street to increase the interest rates charged on mortgages, loans and overdrafts.”