HBOS 'could merge with Lloyds TSB'

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Earlier, shares in the group plunged for a third day in a row amid funding fears, diving as much as 50%, but recovered to 7% down after the report from the BBC. The broadcaster said HBOS and Lloyds TSB were in "advanced" talks over a combination.

Asked about the discussions, an HBOS spokesman declined to comment.

HBOS is the UK's biggest mortgage lender and savings bank. It already has £258 billion of retail deposits, and around 15 million savers.

Lloyds TSB, which does the bulk of its mortgage lending under its Cheltenham & Gloucester brand, is the UK's third biggest lender in terms of outstanding home loans. During 2007, the latest year for which figures are available, it wrote 8% of all mortgages in the UK.

The merger news fuelled a rollercoaster session for London's leading share index, which opened up, then quickly slumped to a 40 month-low before recovering back into the black.

HBOS topped the fallers board at the start of trading, then led the casualty list as its share price plunged.

The group sought to reassure investors over its funding, but it failed to prevent its shares slumping for the third day in a row. The bank's stock fell almost 40% at one point on Tuesday before closing 22% lower. Analysts have said HBOS needs to refinance more than £100 billion of funding during the coming months, which could be more challenging after the blow to confidence from Lehman's demise.

Inter-bank lending rates increased sharply on Tuesday and overnight, making funding more expensive. There were also suspicions that HBOS might have been a victim of "short-selling", where investors make money by effectively betting on the price of a company falling.

The Financial Services Authority issued a statement about HBOS as its share price fell. It said: "Since the beginning of the current extreme difficulties in the financial markets, the Financial Services Authority has worked intensively with all major UK banks to ensure they have credible capital and liquidity plans. We are satisfied that HBOS is a well-capitalised bank that continues to fund its business in a satisfactory way."