Jeremy Warner: The goalposts have shifted dramatically

This is momentous stuff. It's been clear for a long time that the crisis in credit markets is going to change banking beyond recognition, but not until the last few days have the jaw-dropping implications come to be fully understood. Banking the world over is about to become publicly controlled, with Europe and the US now intent on following Britain's lead in recapitalising beleaguered balance sheets.

In the City, there is growing dismay over what now seems certain to be the part, or possibly even full, nationalisation of major banks. In the past few days, the Government has dramatically shifted the goal posts over what is being demanded in terms of new capital.

In their determination to stem the crisis of confidence, regulators are requiring banks to stress-test their balance sheets against the possibility of a prolonged recession, and to recapitalise themselves accordingly. "We want to do this only once," said one government source. "This is belt and braces to buttress the system against anything that might be thrown at it." Yet in the City there is fury over what one banker described as "sequestration". Said one angry adviser: "They won't give us the funding we need to survive unless we dilute our shareholders out of existence." Massive dilution of existing equity holders will raise solvency concerns for pension funds and life assurers. Cancellation of dividend payments will have significant knock-on consequences for savings plans.

There are also implications for credit allocation, in which the Government will now have a say, and executive pay.

This may make the sizeable investment banking operations run by Barclays and Royal Bank of Scotland impossible to manage and could therefore lead to their eventual breakup. Banks will cease to be risk-taking businesses, and instead take on the characteristics of quasi-public utilities. Even after last week's announcement of a £50bn fund to recapitalise the banks, most bankers thought it would be possible to muddle through without diluting their own shareholders, either by raising the necessary funds in the City or by having the taxpayer provide the capital through preference shares, which do not carry votes or a say in the affairs of the bank. In any case, they believed they had until the end of the year to come up with solutions.

Yet such wishful thinking disappeared last Friday, when there was a further meltdown in bank shares and a rising sense of panic in money markets, with interbank rates moving to unprecedented levels.

Treasury and Financial Services Authority officials were locked in frantic talks with bankers all weekend to try to hammer out the recapitalisation of the two most exposed banks – Royal Bank of Scotland and Halifax Bank of Scotland – in time for the resumption of trading this morning.

RBS is being required to raise £20bn of new capital, HBOS £12bn, Barclays up to £10bn, and Lloyds TSB between £5bn and £7bn, in a mixture of ordinary and preference shares. For RBS and HBOS, the sums would dilute existing shareholders to minority positions unless investors can come up with the money themselves. In these markets, that's a big ask.

Government sources dismissed complaints of sequestration as irrelevant. "A huge amount of taxpayers' money is being put at risk here. Do banks have an alternative? Plainly not. They have no cards to play. They are bust without us."

Nevertheless, there is a bad feeling about this. The risk is that news of the dilution will further destabilise the banks, and with everyone running for the exit, the Government will be forced to take them entirely into national ownership. We are at a turning point in history. The markets have failed us, and for better or worse, we are entering a new age of austerity and public control, in which much of the free-market thinking of the past 30 years will be turned on its head.

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