By David Clarke and Dominic Lau
LONDON (Reuters) - The British government held talks with major banks on Monday evening at which the possibility of an injection of public money was discussed, according to a source familiar with the talks.
"The big banks and the chancellor met yesterday night. Recapitalization is one of the options being considered," the source said.
Earlier reports by the BBC and others said three top banks, Royal Bank of Scotland, Lloyds TSB and Barclays were seeking 15 billion pounds ($26 billion) each to help them get through the financial crisis gripping global markets.
The British bank sector talks took place as Iceland's financial authorities took over the country's second largest bank.
News of the talks sent shares in the banks down sharply as investors anticipated a dilution of their holdings.
Royal Bank of Scotland (RBS) was the biggest loser, with its shares down 32 percent at 101 pence. Lloyds TSB shares fell 14 percent and Barclays fell 12 percent.
RBS CEO Fred Goodwin declined to comment on the reports. Lloyds TSB also declined to comment. A Barclays spokesman said it had "categorically not" requested any capital from the government.
The UK Treasury declined to comment, but said it would do whatever was necessary to maintain stability.
"As the Chancellor (of the Exchequer Alistair Darling) said yesterday, we will do whatever it takes to maintain stability and support a well-functioning banking system," a spokesman said.
A spokesman for Prime Minister Gordon Brown's office said he would not speculate on possible policy options. Britain's banking regulator, the FSA, declined to comment.
The cost of insuring the debt of the three banks fell sharply on the reports of a possible capital injection.
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.
(Additional reporting by Natalie Harrison and Golnar Motevalli; Writing by Dan Lalor and Andrew Callus; Editing by Quentin Bryar)
