The Treasury steps in to broker merger

Government sources confirmed that emergency legislation would be drafted to overcome any competition obstacles to the merger.

Crucially, Downing Street reaffirmed Chancellor Alistair Darling's pledge last year that saver protection schemes would apply to all banks, not just Northern Rock.

The Prime Minister's spokesman said that Mr Brown was fully behind the Chancellor's commitment to "do whatever is appropriate to maintain the integrity of the UK financial system".

Government sources pointed out that Mr Brown had known HBOS chairman Lord Stevenson and L loyds chairman Sir Victor Blank for years. Sir Victor is a former chairman of Trinity Mirror, owners of the Labour-supporting Daily Mirror.

Number 10 stressed that it was "a matter for the companies involved and there has been no confirmation from either of companies involved of any potential merger". But it went out of its way to underline the Government's commitment to a stable banking sector. Downing Street repeated Mr Darling's pledge in the wake of the Northern Rock crisis last year that depositor protection would apply to all banks. "That's what he said last year and that remains the government position," the spokesman said.

He added that the Financial Services Authority had pointed out this morning that HBOS was "well capitalised".

When asked if Mr Brown had been in direct talks with HBOS chiefs, the spokesman said: "He speaks to all sorts of senior business and financial figures all of the time. I'm not commenting on individual meetings or conversations the Prime Minister may or may not have had."

One Whitehall source said that it was "extremely unlikely" that the contagion would spread to other high street banks.

Work and Pensions Minister Stephen Timms that the lessons of Northern Rock were being heeded.

Another minister said that the handling of the financial crisis proved that Mr Brown was the right kind of leader that Labour needed. "The last thing the public wants is more instability when there's a serious economic crisis going on internationally," the minister said. "If the public want a Prime Minister with strong economic experience then that's what they've got at the moment.

"It is obviously a difficult time but we're doing exactly the right thing. Now is not the right time to look like we're navel gazing."

Shadow Chancellor George Osborne told the Standard: "I have spoken to the chief executives of HBOS and Lloyds TSB. I am confident that a solution can be found.

"With a large rise in unemploy --ment and worries about our banks, people are rightly concerned about their jobs and their savings.

"In the long term, the Government should show leadership and take up our offer to reform the protection of people's bank deposits so that they know their savings are secure."

Number 10 said that it was committed to saver protection and would bring forward legislation as soon as Parliament returned next month. It also pointed out that any allegations of short-selling by hedge funds would be a matter for the FSA watchdog. "If there is any inappropriate behaviour, that's for the FSA to address," the spokesman said.

Lib-Dem finance spokesman Vince Cable said: "It is shocking to see a major British bank brought to its knees by an attack by hedge fund speculators engaged in short selling.

"The FSA must insist that the hedge funds declare their position. It must also outlaw collusion between the hedge funds because they are now hunting in packs. These 'masters of the universe' must be tamed in the interests of the ordinary families whose jobs and livelihoods are being put at risk."