Speculation is mounting that the Government may be preparing to increase its stake in the troubled Lloyds Banking Group, after Chancellor Alistair Darling declined to rule out the option of nationalisation.

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The group stunned the City on Friday by warning of 10 billion in annual losses at struggling HBOS, which it rescued with Government backing at the height of the financial turmoil last autumn.

The taxpayer already owns 43 per cent of the group after pumping in some 17 billion into the two banks, and was left with paper losses of more than 2.5 billion at one stage on Friday as Lloyds' shares tumbled to 40 per cent.

Mr Darling defended the Government decision to broker the merger of Lloyds and HBOS and offer financial backing, saying that failure to do so would have brought down HBOS and potentially collapsed the whole UK banking system.

Speaking from the G7 finance ministers summit in Rome, the Chancellor said the immediate priority was to identify banks' bad assets and "put them out of the system", warning that without this step normal lending to businesses and individuals cannot resume.

Mr Darling said: "I said in January there is a range of options that we will be deploying, a range of levers that can be pulled to help all banks, because I have made it very, very clear that the integrity of the banking system is very, very important.

"What we are focusing on at the moment is making sure that we can identify these bad assets and then deal with that problem. That's our focus at the moment and that will continue not just here but it will continue across the world as well."