Shares in Royal Bank of Scotland opened strongly in heavy early trading in the City this morning as the UK's second largest bank confirmed that it was preparing to raise billions of pounds through a rights issue to shore up its balance sheet.

RBS shares bucked expectations to climb 4 per cent to 380p and lead the FTSE 100 index of leading shares higher as analysts interpreted RBS's move as good news for the troubled banking sector.

Justin Urquhart Stewart, a director at Seven Investment Management, said: “The good news is when you get RBS coming out (it shows) banks are taking action to shore up their capital position and that means they must have a better idea of precisely what exposure they have.”

The bank is expected to announce the fundraising in a trading statement that is due to coincide with its annual shareholder meeting on Wednesday.

Last night it issued a statement saying that it “notes recent speculation about a possible rights issue”.

Analysts at UBS calculated recently that RBS would need to raise about £9 billion to bring its capital ratios in line with other UK banks. A rights issue would help to bolster its capital reserves, which have been stretched by leading the €71billion takeover of ABN Amro, the Dutch bank, last year.

The Financial Services Authority is reported to be involved in discussions with RBS over the rights issue and the Treasury is also thought to have been made aware of the situation. The FSA and Treasury declined to comment.

Goldman Sachs and Merrill Lynch are believed to be coordinating the rights issue. While no final decision has been made, if RBS, which owns NatWest, does decide to go ahead, it could prompt other banks, whose balance sheets have also been strained by the credit crunch, to follow suit.

Leading American banks have raised billions of dollars to repair the damage caused by the sub-prime mortgage meltdown, but British banks have been reluctant to ask shareholders for more funding. Some, such as Bradford & Bingley, have strongly denied any plans for a rights issue.

At least one large shareholder in RBS has said privately that it would demand the departure of Sir Fred Goodwin, the chief executive, as the price for supporting a fundraising move.

There have been rumours of a rights issue by RBS to raise as much as £12 billion for some time, but analysts had argued that the stigma attached to such a move meant that selling assets was a more likely option.

Earlier this month the bank cut 200 staff in its global banking and markets business, mostly in London.

Fears of further job losses in the City mounted yesterday as Merrill Lynch announced 4,000 job losses worldwide, Citigroup signalled its intention to cut costs by up to 20 per cent and UBS prepared to eliminate about 900 positions in London.

As many as 400 jobs could go in Merrill’s London operation as the brokerage reported a further $6.5 billion (£3.26 billion) hit from the credit crunch after what John Thain, its chief executive, called “as difficult a quarter as I’ve seen in 30 years on Wall Street”.

The Merrill redundancies were announced amid reports that UBS was preparing to cut about 900 investment banking staff in London next month, about 10 per cent of its workforce in the City. The job losses would be part of wider cuts, which are expected to exceed 2,000 redundancies worldwide.

Vikram Pandit, Citigroup’s chief executive, said that he planned to cut up to a fifth of the bank’s $60 billion of annual operating expenses. Analysts expect Citigroup to shed about 25,000 of its 370,000 workforce by the year end.

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