City regulators accused market speculators yesterday of deliberately planting false rumours about failing banks in order to earn huge profits from the febrile atmosphere on world markets.
The Bank of England and the Financial Services Authority made extraordinary interventions to stamp on gossip about a banking collapse as shares of HBOS were sent plunging.
As the Bank issued a statement denying any such collapse was imminent, the FSA pledged to crack down on market abuse.
Shares in Britain's biggest mortgage lender fell more than 17 per cent in less than an hour in early trading after speculation swirled that the Bank of England was taking emergency measures to deal with a liquidity implosion at the bank. HBOS and the authorities acted quickly to rebut the speculation and the bank's shares made a partial recovery to close down 7 per cent.
The Bank responded to a barrage of rumours sweeping dealing rooms early yesterday by saying any suggestion that Mervyn King, its Governor, or any other senior executive, had cancelled a trip to the Far East was "complete fantasy" and that Easter leave for Bank staff had not been cancelled.
The Bank insisted there was no crisis at any British lender. "No meetings have taken place or have been scheduled to discuss problems with any institution in the UK," it said.
The rumours were fuelled partly by Mr King's postponement this week of a visit to the west Midlands so that he could monitor events in London as the Bank auctioned £10bn of three-month funding to banks. News of a meeting between the Governor and bank executives today also added to feverish speculation, even though it has been scheduled for some time.
Regulators blamed market abuse in the form of "lies" spread by short sellers for the massive dive in HBOS's share price. Short sellers sell shares they do not own in the hope of buying them back at a lower price.
The FSA rejected the "completely unfounded rumours" and launched an investigation to hunt down the offenders. Sally Dewar, the watchdog's managing director of wholesale and institutional markets, said: "We will not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumours and dealing on the back of them."
HBOS was the worst affected bank in morning trading, though Lloyds TSB, Alliance & Leicester and Royal Bank of Scotland also took big hits.
HBOS reacted quickly to the plunging value of its shares. The parent of Halifax and Bank of Scotland said: "There is not a shred of substance whatsoever to any of these malicious and unfounded allegations that have affected UK banks this morning."
The bank said its liquidity was supported by "access to a deep pool of retail deposits" and its place as "one of the most respected names in the wholesale and capital markets".
HBOS pointed out that it raised £750m of tier-one capital only last week in an offer that was two-times oversubscribed and was taken up by "very high quality" institutions.
HBOS has been a cause of concern for panicky investors in recent weeks mainly because of its use of wholesale markets, which account for 44 per cent of its funding. But, while higher than rivals such as Lloyds or Barclays, the figure is nothing like the 75 per cent that left Northern Rock so exposed to the credit crunch.
The authorities' virtually unprecedented actions in quashing the rumours underline the seriousness of regulators' fears about self-fulfilling speculation of a banking collapse. Bear Stearns' protests that it was financially sound fell on deaf ears last week as counterparties reacted to rumours by pulling funding to the US investment bank.
A fund manager who specialises in financial stocks said: "If Bear Stearns can go from being solvent to bust in three or four days, who is to say it couldn't happen to HBOS? But it is inconceivable that there would be a serious problem at HBOS."
After the events of recent days, the bosses of Britain's biggest banks will tell Mr King today that he must do more to bolster confidence in the banking system. They will tell the Governor he should emulate the US Federal Reserve by doing whatever it takes to instil confidence in the system.
Some banks want the central bank to accept a wider range of collateral for its liquidity loans and to make the special monthly £10bn auctions of three-month money a weekly feature. Industry sources pointed to the high demand for yesterday's auction and Monday's surprise £5bn operation to lend money for three days as evidence of stress in the financial system.
The banks want Mr King to take creative action like the Fed and to set aside his concern about inflation to help unfreeze markets that are stalled by fear. But others argued that the Bank's recent auctions allowed a wider range of collateral in exchange for loans and were in fact large operations for the UK.
HBOS shares closed at 446.25p, down 39 per cent this year.Reuse content