HOWZAT

The FSA was known to be instrumental in the takeover of Alliance & Leicester by Santander earlier this year and Hector Sants himself, the FSA’s chief executive, personally engineered the rescue of Bradford & Bingley, the stricken mortgage provider, by its shareholders.

One of the sources said: “I think Lloyds is in the UK what Bank of America and JP Morgan were in America. They are one of the only well capitalised banks that are a safe haven for troubled assets.”

“The question is on what terms and with what support?” the source added.

Lloyds was lined up last year to step in and takeover Northern Rock but it walked away after the Government failed to offer it the financial support it had sought to press ahead with the deal.

“I don’t think the Treasury will make the same mistake this time,” another source said.

One person close to the talks said that no particular financial support was being sought from the Government, only a promise that a merger would be ushered through with little or no regulatory barriers.

“There’s nothing else that’s being asked for,” the person said. "This is a very good combination".

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 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.

HBOS is the biggest private savings institution in Britain with £258 billion worth of deposits and 15 million savers.

While almost all banks have been targeted by worried shareholders since Lehman Brothers, the US investment bank, filed for bankruptcy on Monday, HBOS has been hit much harder than any others in Britain.

Standard & Poor’s, the agency that assesses the financial strength of thousands of companies, added to the bank's woes yesterday by saying HBOS was “less well positioned to manage the deteriorating operating environment” than its peers.

Deposits at HBOS are regarded by financial experts as safe because the Government has hinted, though never explicitly stated, that it would guarantee depositors of any British institution in trouble, as it did with Northern Rock last September.

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