The Bank of England today performed a startling U-turn today as it bowed to pressure to extend its its emergency lending scheme for Britain's banks until January next year.

The surprise move came after Mervyn King, the Bank's Governor, last week ruled out any extension of the Special Liquidity Scheme, which had been due to close it doors to new applications for support from struggling banks on October 21.

The decision by the Bank to abandon its opposition to extending the scheme, and prolong its operation, reflects the intensity and scale of the upheavals in financial markets since the collapse of Lehman Brothers, the US investment bank, on Monday.

The move emerged after HBOS confirmed it was in merger talks with Lloyds TSB following intervention by Gordon Brown.

Since Lehman's collapse on Monday, shares in HBOS have plunged as much as 68.7 per cent and the Financial Services Authority, the City watchdog, was forced to issue a statement on HBOS earlier today to calm panicked investors.

Mr King had signalled last week that the Bank's hope was to end the SLS as planned and for its place to be taken in part by a new, shorter-term facility due to be set up by the Bank under a wider overhaul of its money market operations, expected to be unveiled this week.

The severe turmoil in markets on both sides of the Atlantic that followed Lehman's failure has multiplied the stresses on Britain's banks, sharply increasing the cost of short-term loans between financial groups.

The Special Liquidity Scheme was set up by the Bank in April after it came under mounting pressure from the City to provide extra support to the banking sector.

Under the scheme banking groups can go to the Bank to swap hard-to-trade, illiquid securities linked to past mortgage lending for much easier to trade Treasury bills issued by the Government.

The banks are then able to use these more liquid Treasury bills as collateral to raise funding in wholesale money markets as part of their usual business operations.

The Bank of England and Treasury have refused to give any details of the scale of take up of the Special Liquidity Scheme, although it is understood that it has been extensively used by banks to bolster the liquidity of their finances.

The Bank and Treasury said that they initially expected the scheme to involve at least £50 billion in funding, although this was not a ceiling, and the amount that has since been handed out is believed to be potentially much larger.

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