The Federation of Small Businesses in Scotland said Lloyds Banking Group and Royal Bank of Scotland had such dominant positions that the small and medium sized enterprises that are the lifeblood of the economy may effectively be forced to bank with them.

After repeatedly complaining that SMEs have been struggling to get credit on affordable terms, the FSB is worried that lack of competition could mean such problems become the norm – whatever banks may say about wanting to support business.

“The only choice which too many small firms feel they have with banking is ‘take it or leave it’,” says Colin Borland, public affairs manager for the FSB in Scotland.

The organisation noted that the government-backed takeover of HBOS by Lloyds TSB, to create Lloyds Banking Group, resulted in further concentration in the market in Scotland, which was already dominated by a handful of players. Scottish Government research in July estimated RBS and HBOS had 40% and 28% of the market respectively while Lloyds TSB had 7.5%.

“The FSB has believed for a long time that the SME banking market in Scotland suffers from a lack of competition, but the banking crisis has left us dangerously close to a duopoly,” said Borland.

In a submission to the Westminster Scottish Affairs Committee’s Inquiry into Banking in Scotland, the FSB warned: “We now have serious concerns about the future of SME banking in Scotland. We are principally concerned that lack of competition will result in small business customers receiving a poor deal from banks.

“Without somewhere better to take their business, an individual trader or small firm is powerless against a massive financial institution.”

The FSB believes the Government should encourage smaller players to compete in business banking to ensure that minnows can benefit from a “real choice”. It is also calling for the introduction of alternative sources of finance and the entry into the market of new players. This might be achieved through the creation of a “Post Bank” via the Post Office network.

The Government should encourage big firms like Virgin that are keen to diversify in financial services.

The FSB did not say how new and smaller entrants might be encouraged by the Government.

As the taxpayer owns 70% of RBS and 43% of Lloyds, ministers would face a potential conflict of interest. Some overseas banks that competed in the UK corporate market foundered in the credit crunch. However, some firms see potential in the lucrative business banking market.

Benny Higgins, who runs the Tesco Personal Finance operation, recently said there was “definitely an opportunity” for the giant retailer in business banking.

A spokesman for RBS said: “We are the only bank offering a combination of a committed overdraft and a price promise to our 1.1 million small business customers in the UK. Over nine out of 10 small business customers in the UK had their overdraft facilities renewed at the same or lower margin. We have funds available and are determined to lend it to support sustainable businesses.”

Donald Kerr, head of commercial banking in Scotland for Bank of Scotland, said: “We have, since the merger of Bank of Scotland and Lloyds TSB Scotland, been actively contacting our customers to ensure that we are supporting them through the downturn and helping prepare them for the end of the recession.

“We note the increased interest in our market from new entrants and we welcome this.

“We think the increasingly competitive landscape is good for our customers and good for us.”