INSIGHT-Crisis haunts British banks in coronavirus relief effort

* Unprecedented demand leads to record loan originations

* Government-backed loan schemes not a 'free-for-all'

* Bankers fear repercussions of poor lending decisions

* Coronavirus challenging bank processing, reputation

By Sinead Cruise, Lawrence White and Iain Withers

LONDON, April 3 (Reuters) - With the future of many coronavirus hit firms in their hands, British banks, still scarred by the financial crisis, are worried that they are being asked by a desperate government to make loans that will never be repaid.

This caution, combined with the challenges of an unprecedented demand for loans, is testing the British public's fragile faith in the lenders, which have spent a decade trying to rebuild their battered reputations and capital positions.

"We've got to only make loans that we can reasonably believe people will be able to repay after the crisis has gone; to businesses which will still be there," Ian Rand, who runs business lending at Barclays, told Reuters.

Government, banks and regulators say there is no shortage of capital to support businesses under a $400 billion government relief package for struggling companies.

But of around 130,000 inquiries received as of Friday for the Coronavirus Business Interruption Loan Scheme (CBILS) for smaller firms, only 1,250 loans totalling some 145 million pounds ($179 million) had been made.

A separate Bank of England programme to support larger firms has so far provided 1.9 billion pounds of support.

"The scale of this process and the speed with which it has been put in place has been more than expected. The volume has been absolutely massive, calls went up by 45 times," Royal Bank of Scotland Chairman Howard Davies said on BBC Radio, adding that the lender had rehired retired staff to help it out.

Bank call centres were initially overwhelmed by applications for help from firms who were ineligible or who believed the scheme offered handouts instead of more debt, highlighting the wider impact of the coronavirus crisis on the economy.

British finance minister Rishi Sunak on Friday extended support to mid-sized firms, those with annual turnover of between 45 million to 500 million pounds, that had been effectively excluded from the initial package.

Bankers welcomed the ditching of a requirement to assess whether a business was first eligible for a commercial loan before being accepted in the scheme.

A study by the Corporate Finance Network before Friday's changes found nearly a fifth of small companies were unlikely to survive the next four weeks, despite the state support net.

TERMINAL DECLINE

With government guarantees covering 80% of the value of a loan, banks are on the hook for the remaining 20%, leaving bankers feeling caught between the pledges of relief and a duty to safeguard taxpayer and shareholder cash.

The banks, who were saved by taxpayer funds in 2008, were put on notice this week by business minister Alok Sharma who said it would be "completely unacceptable" them to abandon "good" businesses in financial difficulty.

"It's all very well saying ... you are making a scheme available, it's another thing to put it in operation quickly," Andy Halford, Standard Chartered's chief financial officer said, adding "the devil is in the detail".

An executive at one smaller British bank, who declined to be named, acknowledged a "public duty" to help those in need but said there were limits to what could be offered.

"At the moment it's about survival for these businesses that have had a huge hole blown in them," said another executive, adding that his bank was prioritising existing clients but would struggle to help others.

Naresh Aggarwal of the Association of Corporate Treasurers said many of its member companies that were otherwise viable were struggling, but acknowledged banks are in an unenviable position.

"There is a real risk that in two or three years' time, we realise companies that were saved really shouldn't have been saved because they were already in terminal decline," he said.

Analysts at KBW calculate that bad loans for the top British banks are likely to hit 31 billion pounds in 2020, some 23 billion pounds more than forecast prior to the pandemic.

The FTSE 250 mid-cap index is full of firms with thousands of staff and turnover in the billions, many of which are wholly dependent on their banks to provide them with borrowing facilities, Aggarwal added.

"There are some businesses that are re-engineering themselves, and which are the future, but who will just get crushed because they can't present the right numbers right now."

DISASTER FOR EVERYONE

Bankers have been pressing politicians and regulators for leniency in the way forbearance - effectively a blind eye to faltering borrowers - is recognised in accounts.

Failing loans that aren't repaid or restructured typically require hefty provisions and lenders are concerned that backing poor prospects now will later lead to huge losses.

The Bank of England issued guidance clarifying that relief offered to firms should not automatically be classed as impairments and warned against making dire forecasts when the outlook remained so uncertain, but concerns remain.

While the stimulus would help mitigate an economic slowdown, credit ratings agency Moody's said it could weaken banks' asset quality and could lead to a significant increase in bad loans.

"They're now faced with making decisions on who to provide additional flexibility to or not and they're not throwing their risk appetite out of the window," Laurie Mayers, associate managing director at Moody's, said.

This balancing act by the banks will be crucial for the shape of the business landscape once the crisis recedes.

"It is a disaster for everyone - but unless we save SMEs there will be little to stimulate recovery," said Jasper Smith, founder of Vala Capital, which invests in tech, gaming, food and engineering start-ups. ($1 = 0.8110 pounds)

(Editing by Alexander Smith)