Britain’s leading banks have been insisting for weeks that they do not need more capital. All are above or close to the level required by regulators. In normal times they would have enough. But these are not normal times.

After the recent bank collapses, particularly that of Lehman Brothers, lenders to banks are in a funk. They are now so nervous that they will lend money for any length of time only to banks that they think are rock solid. Banks themselves are hoarding cash. Fairly solid banks are finding it hard to fund themselves. Those with any question marks over their finances are finding it nearly impossible.

The Bank of England has been trying to provide the funding by dramatically increasing its lending to banks. But, despite its efforts, the so-called wholesale funding markets for banks are virtually frozen. This translates into more expensive lending to individuals and companies, with serious implications for the economy.

The Bank believes that it has reached the limit of what can be done without the banks raising more capital. The problem is, investors are hardly queueing up to put more money in. Investors who put £12 billion into Royal Bank of Scotland and £4 billion into HBOS this year are sitting on big losses.

That is where the Government comes in. The plan is to increase the amount of capital that all big British banks are expected to hold and to offer public money to those that can’t raise the extra capital elsewhere.

The strongest big British bank – HSBC – may be required to raise little or no extra capital. For RBS, Lloyds and Barclays, the estimates range up to £15 billion.

The interest rate on the public money will be high, to penalise the banks’ shareholders and ensure that the taxpayer should get a decent return.

With luck, the taxpayer could make a tidy profit, as happened with the Swedish bank rescue plan in the early 1990s.

In return for the money, the Government is expected to get so-called preference shares, which will rank above existing ordinary shares in terms of their rights over the banks’ assets. The Government will also get the right to new ordinary shares and possibly a seat on the board.

It is assumed that the effective price that the Government would be paying for these shares would be significantly less than the price at which they have been trading in the market. It is also expected that banks taking public money would have to cut or eliminate dividends to existing shareholders.

That is one reason why most bank shares fell sharply yesterday. RBS fell 39 per cent and HBOS was down 42 per cent, in part because the market is expecting that the terms of its takeover by Lloyds TSB will be renegotiated. But shares in HSBC were up.

The Bank and the Treasury believe that the move will benefit all banks, including HSBC, by restoring confidence among investors and reviving the money markets. But many bankers believe that other measures will be needed, including a guarantee on all deposits in British banks.

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