Watchdog tells Lloyds it must take taxpayer help to cover bad loans

The City watchdog has told Lloyds Banking Group that it has no choice but to enter the Government's asset guarantee scheme.

Speculation has been mounting that the bank could avoid entering the scheme with the help of a rights issue, after the company said at its recent interim results that bad loans had "probably peaked".

However, it is understood that the stress tests designed to gauge whether the bank will manage without it came out negative.

Lloyds shares surged following its results and investors privately told the bank that they would be willing to back a cash call in the hope that an economic upturn would result in a marked recovery in the bank's finances and share price.

The scheme is viewed as expensive and requires the bank to burn through at least £25bn of losses on the assets it covers before it kicks in. Some £10bn has already been lost on them, but the rate of decline appeared to be slowing.

At the results chief executive, Eric Daniels, said the bank would need to enter the scheme as "fire insurance" even though it might not need to call on taxpayers' cash.

Lloyds has done little to damp down the frenzy of speculation over a possible cash call to avoid it in recent weeks.

Analysts have privately voiced unhappiness over what they have seen as a lack of clarity from Lloyds over its intentions while the tests have been conducted.

They are understood to have been based on ultra cautious assumptions, which the bank was unable to meet. The watchdog has been taking an increasingly conservative stance on the banks.

However, similar such tests were applied to Barclays several months ago, and found that it would not need any government cash although the bank has since raised capital through disposals and "de-risking" exercises.

Both Lloyds and the Financial Services Authority declined to comment last night.