Taxpayer-backed Lloyds Banking Group has hailed a "significant milestone" as it returned to profit in the first half of this year with a £1.6 billion surplus.

The result came as a marked turnaround on the £4 billion of losses seen a year ago and was better than expected by most analysts.

Lloyds, which is 41 per cent owned by the taxpayer, said sharply lower bad debts helped its recovery, with losses on loans turned sour more than halving in the first six months of 2010.

Business Secretary Vince Cable has also called for dividends and bonuses to be targeted in a "carrot and stick" approach to boost lending to cash-strapped small firms.

Lloyds has committed to gross business lending of £44 billion in the year to March and £23 billion in mortgages in return for State support, but it fell way short of last year's Government-set target for business loans.