Shares in Royal Bank of Scotland (RBS) collapsed yesterday, dropping 39 per cent amid fears that shareholders’ investments would be wiped out in a part-nationalisation of the UK banking sector.

Alistair Darling was due to tell the City early this morning that the Government will make about £50 billion available to recapitalise Britain’s biggest banks by taking a chunk of their stock. The Government was expected to demand convertible preference shares, or preference shares accompanied by warrants that would give taxpayers exposure to any improvement in the banks’ share prices.

RBS is likely to be the worst affected because its capital ratio is the weakest, and so it would need the most cash to hit a new minimum target. As a result, its shareholders would be the most drastically diluted.

Traders said that pension funds were among the biggest sellers of RBS’s stock, forcing its price down to 90p by the market’s close. Its plunging value will be a blow to shareholders who supported RBS’s £12 billion rights issue in April at 200p per share.

One trader said: “This Government lives by the dog whistle of Middle England and if it thinks that beating up on equity-holders will appeal to voters, they’ll do it even if it causes huge longer-term damage to our pensions. We’ve had people just throwing up their hands and saying that anything’s possible now.”

About 485,000 RBS shares changed hands yesterday, 4½ times more than usual. In a statement to the stock market yesterday, the bank said: “Contrary to press speculation, RBS did not make a request to Government for capital.”

Also yesterday, John Varley, chief executive of Barclays, said: “Barclays has not requested capital from the Government and has no reason to do so.”

On Monday Standard & Poor’s downgraded RBS’s financial profile to AA- from A+ and said that the bank had a “negative” outlook. The ratings agency said that RBS would struggle to sell the assets that it must offload to hit its target of a 6 per cent core equity Tier 1 ratio by the end of the year.

RBS needs £4 billion in net gains from disposals to hit its Tier 1 target but is struggling to sell its insurance business, including the Direct Line and Churchill brands. It is thought to have made just over £1 billion in net gains from disposals so far.

S&P has also put Barclays on a ratings watch negative because both banks are likely to also suffer from a downturn in the economic climate.

RBS’s ratio was eroded by its leading role in the €71 billion (£55 billion) consortium takeover of ABN Amro last year. It was also a heavy supplier of leveraged finance in private equity buyouts, making its balance sheet more risky.

Alex Potter, banks analyst at Collins Stewart, said that he was stunned at the suggestion that RBS was in greater need of a government bailout than its closest rival, Barclays. He said that the sum of the banks’ exposures to collateralised debt obligations, American sub-prime mortgages, Alt A mortgages, leveraged finance, commercial mortgage-backed securities and mono-line insurers suggested that the position of Barclays was equivalent to 88 per cent of shareholders’ funds, and RBS’s is 63 per cent. He added: “RBS has taken better marks already, so its exposure is relatively lower and also, in my view, closer to economic reality.”

When preparing for its rights issue, analysts said that RBS had “kitchen-sinked” its credit market exposure, taking far larger writedowns than competitors. Figures compiled by Sanford Bernstein show, for example, that the bank has taken a 65 per cent mark-down on its book of sub-prime retail mortgage-backed securities (RMBS), which is worth £257 million compared with Barclays’s £2.4 billion, which is 41 per cent down. RBS was the world’s sixth-largest supplier of leveraged finance between August 2005 and August 2007, lending $128.8 billion (£73.5 billion). About £10 billion of this still sits on its balance sheet. Figures from Thomson Financial show that Barclays lent $76 billion in the same period.

RBS has £3 billion-worth of debt maturing by the end of the year, compared with Barclays’s £5 billion. Both repayments are dwarfed by those of HBOS, with £8 billion outstanding.

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