Bank shares plummet as uncertainty grips market

Bank shares dived and money markets hit new levels of seizure yesterday, piling pressure on the UK Government to take further action to shore up Britain's financial system.

Royal Bank of Scotland was the biggest faller among the banks, dropping more than 20 per cent, closely followed by HBOS which fell almost 20 per cent. Barclays fell nearly 15 per cent.

The sell-off partly reflected renewed panic about banking stocks after a series of bailouts in Europe cast further doubt on banks' security. But there was also concern that if the Government took equity stakes in banks it would dilute existing shareholders.

Industry sources said an option for the Government would be to take stakes in preference shares or convertible stock, limiting the dilutive effect on equity investors. But there are also concerns that, in return for its support, the Government would demand curbs on dividend payments to shareholders.

The Chancellor, Alistair Darling, told Parliament yesterday that the Government was keeping "all options open" and would do "whatever is necessary" to maintain financial stability. He did not refer to specific options, such as taking equity stakes or responding to the wave of deposit-protection guarantees being put in place in Europe.

The Government is resisting following Ireland in guaranteeing all bank deposits after announcing an increase of the retail deposit guarantee to £50,000 from £35,000 that takes effect today. Industry sources say taking equity stakes to boost bank capital would be a cheaper, shorter-term measure to demonstrate state backing than underwriting deposits.

But bankers said yesterday that boosting liquidity and not capital was the key measure required to unfreeze the system and prevent a severe economic downturn.

Money market rates, which gauge the level of confidence in the financial system, rose worldwide as banks hoarded cash. The overnight dollar Libor rate rose 37 basis points to 2.37 per cent, the first jump in four days. The three-month rate was close to the highest since January, while the Libor-overnight indexed swap rate was close to record levels.

British banks are said to be pressing for a permanent and comprehensive liquidity scheme to allow them to get assets off their balance sheets and secure funding to lend and restore confidence.

RBS's share fall was exacerbated by a ratings downgrade on the bank's debt by Standard & Poor's. The ratings agency made its first cut to RBS's rating for nearly 10 years because of the bank's weakening "financial profile", even after Britain's second-biggest bank raised a record £12bn from shareholders earlier this year.

The fall in HBOS's shares widened the discount between the bank's share price and the agreed all-share offer from Lloyds TSB to 25 per cent, indicating market jitters that the deal could be derailed.

The Government will set out details of its banking reform legislation today. The Bill will include formal measures for the authorities to take control of a failing bank and will give the Bank of England statutory responsibility for maintaining financial stability.