NEW YORK — Billions of federal bailout dollars are flooding the financial system, credit markets are loosening and many banks say they are ready to lend. But a crucial piece needed to solve the credit crisis is still missing: borrowers.

With the economy slowing, banks are seeing a big decline in the number of people seeking loans because nervous consumers and small businesses are scaling back their borrowing.

The slide in loan demand has been a hallmark of past downturns, and it could thwart the government's attempt to increase lending with an injection of $250 billion in emergency cash. This is one problem that has nothing to do with whether a bank is healthy.

"It's not us saying we won't lend money — it's borrowers saying they don't want it," said William Dunkelberg, chairman of Liberty Bell Bank in Cherry Hill, N.J., which in the past year has seen loan demand cut by about half across its four branches.

In his city of 70,000 people, he said, banks are taking out ads to assure customers that they are sound and have money to lend.

"We're letting people know that the credit crunch isn't here. That's a Wall Street problem," said Dunkelberg, who's also chief economist for the National Federation of Independent Business.

SMALL-BUSINESS IMPACT

The borrowing drought has been most dramatic among small businesses, which employ half of all private-sector workers.

In fiscal 2008, the number of small business loans issued by banks plunged 30 percent compared with the previous year, according to the U.S. Small Business Administration. Over the same period, the dollar value of those loans fell from $20.6 billion to $17.96 billion, a 13 percent drop.

The pullback is partly a result of tighter credit availability among lenders and declining creditworthiness among borrowers. But it also reflects a big drop in consumer spending that is forcing small businesses across the country to put off expansion plans and cancel orders for new equipment.

"I get loan offers from banks all the time, and I just throw them away," said Dr. Mark E. Harris, a dentist in Riverside, Calif., who bought his practice three years ago.

Harris would like to buy a new digital X-ray machine among other upgrades, but he is wary of taking out a loan to cover the $40,000 purchase and setup costs.

"It's just too hard to predict my cash flow from month to month," said Harris, whose business is down about 25 percent over the past year. "Several patients have canceled appointments lately because they're scared they'll get laid off if they ask for time off."

ANXIOUS CLIENTS

The reluctance to take on loans boils down to fear.

Ilya Bodner, owner of Initial Underwriting Group in Columbus, Ohio, said he's noticed a sharp increase in anxiety among his roughly 1,500 clients nationwide, who hire his company to help secure startup and expansion money and handle debt restructuring.

One of his clients, the owner of a successful roofing company, recently scuttled plans to buy out a competitor and pulled out of $5 million in loan agreements because of worries that business could dry up.

"The loans are there, but a lot of my customers are afraid they won't be able to pay them back," said Bodner, adding that the nervousness extends to entrepreneurs who want to launch a business but don't dare.

The skittishness applies to banks as well.

Since the mortgage meltdown, fears that borrowers won't repay loans have forced banks to tighten lending standards. Those concerns have also hurt demand for asset-backed securities — or loans that banks package and sell to investors.

If they can't sell the loans, banks have to hang onto them for longer, reducing their ability to lend more money.

LENDING DILEMMA

Hoping to spur banks into ramping up lending, the Treasury Department last month rolled out its historic $700 billion financial bailout plan. A $125 billion chunk began flowing into nine major banks last week. And more than a dozen sizable regional banks have preliminary agreements to share a part of an additional $125 billion.

In return for the attractively priced capital, banks are giving the government preferred shares that can be bought back in the future.

The Treasury's goal is to revive lending — and thereby stem the credit crisis — by freeing up potentially massive amounts of loans. For every dollar a bank keeps as capital, it can lend out as much as $10, which means the $250 billion injection could in theory result in $2.5 trillion in available loans.

But banking experts say lending such a vast amount would be almost impossible given the economic downturn.

If they can't make loans, many banks may hold on to the government capital until stability returns — or use the money to finance takeovers of weaker rivals. Pittsburgh-based PNC Financial Services Group Inc. did that last month when it acquired Cleveland-based National City Corp. — hours after receiving approval for $7.7 billion from the government.

If banks don't increase lending, Washington may turn up the pressure on them or try to retroactively impose guidelines about how the government capital is used — regardless of the weak loan demand.

"Policymakers in Congress may overlook this and say 'We don't care. We want to you to lend the money out anyway,' " said Bert Ely, an independent banking analyst in Alexandria, Va. He added: "More strings are going to be put on this money."

EXPECTING A SLUMP

In the meantime, banks are already bracing for a drop in business.

"We expect loan demand to remain weak into early 2009 based on current forecasts for the economy," said Lewis F. Mallory, Jr., chairman and CEO of Starkville, Miss.-based bank Cadence Financial Corp.

So what could break the lending logjam? Time, for one thing.

If small businesses see that the bailout is starting to take hold and confidence is returning, they will be more likely to seek loans, helping kick-start the economy's recovery, according to experts.

In a hopeful sign, interbank lending rates fell for the 19th straight day last week, showing that banks are more willing to lend to one another. The interbank lending rate known as the London Interbank Offered Rate, or Libor, fell to 2.39 percent for three-month dollar loans. That's down sharply from a peak of 4.82 percent on Oct. 10.

One business owner looking for signs that it's safe to borrow again is James Duran, CEO of a Silicon Valley staffing company that does business with big tech companies such as Google Inc. and Yahoo! Inc.

Last year, he had as many as 200 employees. Today, he's got just 15 — cutbacks that mirror job losses across his industry.

He said he has a $1 million line of credit to help build back his company but that he would be "crazy to use it now."

"Once I see this cloud of uncertainty lift and companies go back into hiring mode, I'll start using that money," he said. "But we're not even close to that."