The banking industry suffered a new blow yesterday as London Scottish Bank admitted that it needed to raise fresh capital.

The consumer lender became the first London-listed bank to admit that it had been ordered by the Financial Services Authority to increase reserves dramatically under new rules on capital that come into force today.

LSB shares closed down 18 per cent, or 14p, at 63p after it said bad-debt woes would force it to take a £22 million impairment charge for the year to October 31. The charge would result in an annual loss of up to £5 million and threaten the final dividend, it said.

The value of the bank, which has about 220,000 customers and more than 2,000 staff, fell to £89.7 million. Robin Ashton, the chief exective of LSB, said he would begin urgent talks with the FSA over the £13 million shortfall in its reserves. He said the problems came after some low-income customers of its unsecured-credit business failed to repay loans.

The business lends to those in the C, D and E socio-economic bands – equivalent to the sub-prime lending market in America where the failure to repay mortgages led to last summer’s financial crisis and the run on Northern Rock. Mr Ashton, who was appointed last month from Provident Financial, said the group would try to raise capital – either through a share issue or asset sales – as soon as possible.

Losses could swell to more than £17 million if an interim one-off charge relating to the company’s broking arm was also taken into account.

However, Mr Ashton denied that the bank’s problems were similar to those of Northern Rock, or a symptom of growing problems in Britain’s sub-prime sector. “This is a completely separate issue,” he said. “LSB’s unsecured consumer credit business has been underperforming for some time and rationalisation of the branch network [from 100 to 52 branches] has been going on for nearly two years.

“The additional impairment provisions are being made to reflect the current value of certain arrears accounts.”

Mr Ashton added that LSB maintained a strong balance sheet and was in compliance with all the convenants in its banking agreements. The capital position was recently boosted by the sale of its head office in Manchester and a leasing business, which raised a combined £42 million.

Mr Ashton said he discovered that some of the bad debts had not been properly accounted for while going through the books ahead of full-year results. The problems were compounded by new capital reserve rules, known as Basle II, under which banks across Europe must clear new reserve levels with their national regulator.

Jim Wood Smith, of the investment manager Williams de Broë, said the problems at London Scottish would not automatically trigger a collapse in the sub-prime sector.

“Everyone has known for some time what the tougher capital requirements will be under Basle II so it is a bit of a surprise that London Scottish appears to be suggesting it has been caught napping,” he said.

How rules changed

— The Basle II capital rules change fundamentally the way eurozone banks assess financial risks and the amount they have to hold in reserve to cover potential losses

— The rules replace the 1988 accord under the auspices of the Swiss-based Basle Committee on Banking Supervision

— The aim is to reflect risk more accurately: instead of holding a fixed percentage of assets to cover the chances of market, credit or operational failures, banks first assess their own positions, then clear them with the regulator

— More sophisticated investment banks will use their own risk models. America comes under Basle II next year

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