Britain and its banks will hold more urgent talks over a possible multi-billion pound injection of public money into the sector over coming days, an industry source said as the financial crisis tightened its grip.
News of talks held on Monday night between the banks and the with Chancellor of the Exchequer Alistair Darling sent shares in Royal Bank of Scotland, Lloyds TSB and Barclays plunging on Tuesday as investors feared their holdings might be diluted if the government were to buy a big stake.
The cost of insuring the banks' debt fell on hopes the new capital could take the pressure off existing debt.
Some reports said the banks were seeking 15 billion pounds ($26 billion) each to help them get through the crisis, which began in the United States last year when mortgages holders defaulted on payments.
The source told Reuters the next round of talks will focus on what form of equity the government would receive in return for providing banks with any injection of taxpayer's money.
"That's what they will be working on over the next couple of days," the source said.
The UK Treasury declined to comment on the talks, but a spokesman repeated that Darling, Britain's finance minister, has said he will do whatever is necessary to maintain stability.
"We are not speculating on possible policy options," said a spokeswoman in Prime Minister Gordon Brown's office. Britain's banking regulator, the FSA, declined to comment.
Britain's action came as governments around the globe fought to restore confidence in the banking system. In the latest of a series of emergency actions, Iceland's financial authorities took over the country's second largest bank.
"I think what this signals to me is that this isn't a situation where banks can muddle through. They're going to have to be recapitalised and they're going to be heavily dependent on government and the authorities for sources of funding," said Simon Pryke, head of global research at Newton Asset Management.
"The important thing to put across is that governments are very focused on rescuing their banking systems but that doesn't necessarily mean rescuing bank shareholders."
BANKS TIGHT LIPPED
The banks themselves were either not commenting or careful to make clear they were not asking for government money.
Barclays chief executive John Varley said "contrary to press rumours, Barclays has not requested capital from the government and has no reason to do so".
"HBOS has not asked for capital from the government," a source familiar with the situation said.
RBS declined comment, as did Lloyds TSB, which has made a government-brokered takeover approach to HBOS as part of an earlier attempt to shore up the industry.
RBS raised a record 12 billion pounds is fresh capital earlier this year. Barclays raised 4.5 billion pounds in July from investors including Qatar and Japan's Sumitomo Mitsui and only last month raised a further 701 million pounds from a share sale.
Shares in Royal Bank of Scotland (RBS) were the biggest loser, with its shares down almost 40 percent at one point, and off 25 percent at 111 pence in late morning trade. Lloyds TSB shares fell 8 percent and Barclays shares fell 6 percent.
However, five-year senior credit default swaps on RBS were about 30 basis points tighter at 270 basis points and about 20 basis points tighter at 230 basis points on Barclays, a trader said. That means investors have to pay 270,OOO and 230,000 euros to insure 10 million euros of the respective banks' debt against default.
"It's more of an equity story, as it look like shares will be diluted, while a capital increase is credit positive which explains how the CDS has reacted," a credit trader said.
Short sterling futures jumped as the bank shares tumbled and as weaker-than-expected economic data strengthened demands for a Bank of England rate interest cut later this week.
