High street banks are monitoring the potential for new business following the Government’s proposal to allow grant-maintained schools to borrow on the commercial market.

The announcement by Education Secretary Gillian Shephard earlier this year received a mixed response from the banks, most of which offer specially designed business packages to schools - both GM and locally managed - in an increasingly competitive market. Until recently schools tended to use the banks recomm-ended by their local authorities, but they have started to shop around.

The larger banks initially regarded schools as a mixed blessing. They cannot legally be overdrawn or go into liquidation so, while they are a safe bet, they never pay interest charges on loans. However, the prospect of lending to opted-out schools has attracted renewed interest in the financial sector.

Though two of the big four - Midland and Lloyds - now have packages for schools, it was the TSB, the Co-operative Bank, and the Yorkshire Bank that first spotted the potential of the market and set the financial pace. They still retain the largest share of the market, with higher interest rates on school current accounts.

For schools with sizeable reserves, above-average gross interest rates still remain a key factor when choosing a bank. With this in mind, the Co-operative schools package currently guarantees the highest return - 5.75 per cent and commission-free banking on balances over Pounds 5,000.

To schools with less than Pounds 5,000, the TSB offers the most attractive interest - 5.25 per cent irrespective of the amount held in the current account. The Yorkshire Bank runs a sliding scale from 2.5 per cent on balances below Pounds 9,000 to 5.25 per cent on Pounds 25,000 and above. Schools with up to Pounds 25,000 to invest will find the gross interest rates offered by the big four significantly lower. The best financial deal currently offered is through the Midland’s education account which pays gross interest of 4. 4 per cent on balances up to Pounds 25,000 and 4.9 per cent on those above Pounds 25,000.

Lloyds School Managers Account pays 3.4 per cent interest on balances over Pounds 1,000 and 3.95 per cent gross interest on balances over Pounds 50, 000.

Barclay and NatWest, which were unable to give details of their share of the market, offer services tailored to individual schools, but their current accounts pay lower rates of interest. However, Barclays’ community current account includes free transactions on the first 10 debits.

Most offer services such as payroll handling at a price - mostly to opted-out schools who manage their own staff payments. Midland and Lloyds offer an automatic sweep facility, switching current accounts above a certain level into interest-earning deposit accounts, and many have telephone and electronic banking linking the school computer to the banks for easy monitoring of funds and balances.

The Co-operative, which last month launched its effective schools package, also offers a school cash card. Lloyds’ package includes two annual commission-free currency exchanges for school trips abroad.

Geoff Pulter, head of business banking at Midland, which has trebled its number of school accounts since the launch of its commission-free education account last year, said the bank already made loans to a sizeable number of independent schools and higher education colleges. Loans to opted-out schools would have to be arranged like any other business account, he said.

“I believe it would be unthinkable for banks to loan to schools on the basis that we may have to get our money back by selling their security. Instead we will be looking at lending against their cash flow, which is to some extent predictable - provided that the school is popular and attractive to its customers - and is therefore a viable business proposition.”

One in four GM heads questioned in a TES survey last October said they would not hesitate to take out a loan on their school’s behalf, though nearly half (46 per cent) ruled out the idea.

Martin Parker, Lloyds assistant business banking manager, said: “At present we are looking at the Government proposals with a very open mind to see how we can help our customers and what the benefits are to ourselves - it is all a question of assessing the risk.”

However, Martin Howarth of the Co-operative, which has 15 per cent of the GM, locally managed and independent schools market, felt certain the proposals would not radically affect its share of the sector. He believed credit balances in schools were likely to drop over the next few years as heads and governors spent up to their limit to avoid being penalised for carrying over large reserves. This would make them a less attractive proposition to those banks with a smaller share of the market.

He said: “The fact that there are only 1,000 GM schools with the potential to borrow will not generate enough extra interest among the big four banks. But the fact that we are already targeting GM schools is an added incentive for us. We would still regard them as a safe bet in comparison to general businesses. ”

David Brophy, senior product manager at the TSB, which has the lion’s share of GM school business, agreed. “Schools have a general reluctance to borrow, Just because they may be given the facility to overdraw or borrow does not mean they will want to do so, I feel sure the facility will be fairly limited in application.”