Lloyds TSB is in advanced talks to buy HBOS, Britain’s biggest mortgage lender, sending shares in the battered bank up 15 per cent.

Talks between Britain's fourth and fifth biggest banks emerged after the Financial Services Authority (FSA), the City watchdog, was forced to issue a statement on the strength of HBOS’s business to stop a freefall in its share price.

Share in HBOS dropped by more than 50 per cent to just over 80p this morning as panicked investors dumped their stock.

HBOS shares have been savaged by investors since the beginning of the week after Lehman Brothers’ bankruptcy ignited fears about the UK bank’s exposure to the mortgage market and its ability to fund its business.

Both HBOS and Lloyds TSB refused to comment today but HBOS is likely to be forced by the UK listing authority to update the market later today.

Shares in HBOS fluctuated wildly this morning, rising as much as 15 per cent after the talks with Lloyds TSB emerged. By mid-morning, HBOS stock was up 6.98 per cent to 194.8p.

Lloyds TSB has previously said that it would look at acquisition opportunities as other companies struggle in current torrid financial markets. Lloyds' shares rose 9.8 per cent to 307.35p.

In its statement today, the FSA 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".

Last night the US Federal Reserve saved American International Group (AIG), one of the world's biggest insurers, from the brink of collapse after America's central bank agreed an $85 billion (£47 billion) bailout of the company.

The bailout sent London's FTSE 100 index of leading shares up 54.8 points to 5,0804 today after closing down 178.6 points yesterday before detail of the AIG deal emerged.

The rescue gives the US Government a 79.9 per cent stake in the insurer. The central bank hopes that the rescue loan will halt plummeting financial markets, reeling from the collapse of Lehman Brothers and sale of Merrill Lynch at the weekend.

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