Britain’s mortgage lenders face a £30 billion funding shortfall next year if the Bank of England does not step in to ease the credit squeeze, the industry’s lobby group said yesterday.

As much as a third of the £90 billion required to finance the demand for mortgage loans expected next year will need to come from money markets that effectively have been closed since August, the Council of Mortgage Lenders (CML) said.

But as the CML pleaded with the Bank to intervene to prevent a severe contraction in the availability of mortgages, banks were told to get their own house in order by the City’s regulator.

The Financial Services Authority (FSA) said that lending conditions could get worse and that lenders should forgo profits to protect themselves against a collapse in liquidity of the sort that crippled Northern Rock.

The stark warnings, presented yesterday at the CML’s annual conference in London, come at a time of deepening gloom over Britain’s mortgage market. New loans for house purchase are down by 31 per cent over the past year and all big surveys have shown house prices falling in recent months.

Funding stresses in the London money markets continue to mount. One-month sterling interest rates for loans between banks rose still further yesterday, after they leapt on Monday to a nine-year high, registering the sharpest gains for 13 years.

Michael Coogan, the director-general of the CML, said that the Bank of England needed to take the lead in restoring confidence by allowing a wider range of mortgage-backed assets to be posted as collateral against loans. He said: “It is not an arcane issue – this is an issue that could affect every consumer in the UK. If the markets don’t open up we will have a much smaller, less innovative mortgage market going forward.”

The Bank should also help to restore confidence in wholesale markets by cutting interest rates tomorrow, he added.

But Clive Briault, the head of retail markets at the FSA, said that banks should “assume that market conditions will remain very difficult for a sustained period”.

He urged them to ensure that they had adequate levels of liquidity, despite the higher costs involved at present. “But it would be prudent to pay a correspondingly high price – and to forgo some profits – to secure this protection, or otherwise to scale back balance-sheet growth,” he said.

Firms should carry out robust stress testing and examine what state they would be in if they had no or only limited access to wholesale funding for a sustained period, Mr Briault said. They should also make contingency plans for the worst outcomes.

He told lenders: “There is almost certainly more change to come. It is very unlikely that we will return to the conditions that prevailed before August . . . It is clear that some business models are no longer as economically viable as they used to be.”

Homeowners with high loan-to-value ratios on their mortgages will face heavy difficulties refinancing their loans next year and many will face unaffordable rates, he said, but banks should not forget their obligation to treat struggling customers fairly.

Mr Briault added that sub-prime borrowers might not have access to the market at any price until normal conditions returned.

The mood was darkened further by a research note from Morgan Stanley, the Wall Street bank, saying that it had removed Bradford & Bingley from its banking portfolio. “Our UK banks analysts suggest international investors should avoid UK banks at the moment, given the structural and systemic issues,” it read.