UK competition watchdog considers small business banking probe

* Watchdog will decide whether to launch full probe later in year

* OFT says SMEs may not be getting best deal from banks

* UK finance ministry 'determined to increase competition'

* Big 5 lenders account for three-quarters of SME lending

By Matt Scuffham

LONDON, March 11 (Reuters) - Britain's new competition watchdog will decide later this year whether to launch a full-blown investigation into the services provided by banks to small businesses, the Office of Fair Trading (OFT) said.

The OFT raised concerns that lending to small and medium-sized enterprises (SMEs) is dominated by a small number of major banks, that it is too difficult for new banks to enter the industry and that it is hard for small firms to differentiate between lenders.

"A concern is that these factors, in combination, may reduce the incentive for providers to compete on price, invest in service delivery and quality or innovate, which may mean that SMEs do not get the best deal for their banking provider," the OFT said in a statement on Tuesday.

Britain's biggest five banks - Royal Bank of Scotland (LSE: RBS.L - news) , Lloyds Banking Group, Barclays (LSE: BARC.L - news) , HSBC and Santander UK - account for around three-quarters of lending to small businesses and lawmakers are keen for challengers to emerge to break their dominance.

Total (NYSE: TOT - news) borrowing by UK SMEs at the end of 2013 was 112 billion pounds ($186 billion), according to the British Bankers Association (BBA).

"The government is determined to support increased competition and new entrants in the banking system, to deliver better results for consumers and businesses," a spokesman for Britain's Finance Ministry said on Tuesday.

A new body - the Competition and Markets Authority (CMA) - is being created by combining the OFT and Competition Commission and will monitor competition issues in Britain from April.

The OFT said that the new watchdog will assess concerns over banking services to SMEs as part of a wider examination of competition in retail banking. It will then decide whether to launch a broader investigation.

Labour leader Ed Miliband has said he will instruct the CMA to produce a report on how to limit the market share of big banks and encourage new competitors should Labour win the next election in 2015.

New entrants such as Aldermore and Shawbrook have already begun to surface in the wake of the 2008 financial crisis, looking to fill a gap as the big banks focus on shrinking their balance sheets and building up capital reserves to meet new regulations.

"It would be helpful if there was greater communication from the government and regulators to ensure that SMEs understand that there are alternatives in the banking sector," Aldermore's Commercial Director Mark Stephens said on Tuesday.

The BBA, a lobby group, said its members were in favour of competition and would work to make sure customers got the best treatment possible.