Nick Clegg appealed today for businesses to tell government how to bypass the banks as he vowed to "break open" the market.
The deputy prime minister accused the banking sector of sitting on its hands over lending as firms continue to complain they cannot access vital finance.
Clegg insisted the Government plans to drive lending by opening up the financial sector to make it more competitive and diverse.
Addressing the Institute of Directors' annual convention, the Lib Dem leader dismissed claims the banks have clamped down on lending to meet new rules in the wake of the banking crisis, insisting the capital targets are being phased in over the next seven years.
He said: "My message to the banks is this: Yes, of course, get your balance sheets in order.
"Meet the new capital requirements. But don't lurch to the other extreme at the expense of British business.
"Don't unnecessarily hoard capital when businesses need loans. Don't sit on your hands while firms are crying out for cash. And understand that getting credit to businesses is in your interests too."
Combined net lending by Britain's top five banks shrank every quarter last year despite the Government's Project Merlin agreement committing them to easing lending, particularly for small businesses.
Clegg said ministers cannot "march into the banks and start taking their individual lending decisions for them" but they can "exert pressure".
He added: "We need to break open the market here in the UK, with more competition within the sector as well as more alternative sources of finance, outside of it.
"The coalition is going to invest directly in non-bank finance as part of our £1.2 billion Business Finance Partnership; £700 million will be invested through up to seven fund managers who will lend directly to British firms. There will be additional investment from the private sector with our share eventually returned to government.
"That still leaves half a billion, £100 million of which will be invested in banking alternatives for SMEs. And, if we see quick take-off, I will certainly want us to invest the remainder as quickly as we can.
"Investments will be made over the coming months, to precisely the kinds of schemes I've described and I'm issuing a call to all of you today: tell us your ideal way to bypass the banks to unlock new channels of capital. How can we help rewire money to the small business world?
"Because yes, we're rebuilding the banking sector to make it safe. Yes, we're intervening to make the banks lend. Yes, we're supporting credit and investment ourselves. But the missing parts of this puzzle are competition and diversity. So tell us what would work for you."
Simon Walker, IoD director general, conceded "middle Britain" has become concerned about the way the economic system works.
He said: "There will always be extreme ideological opponents of the free market. They are, for the most part, on the margins of political thinking, and of policy-making. But we need to take seriously the fact that much of reasonable middle Britain has also become concerned about how capitalism operates.
"One doesn't need to be a protester on the steps of St Paul's to know that business has real problems. If those who are committed to the free market don't try to fix those problems, the enemies of private enterprise will do it for us."
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