Capital stance swayed Lloyds asset decision

By Steve Slater and Raji Menon

LONDON (Reuters) - Lloyds Banking Group said Britain's requirement for banks to hold enough capital to withstand a severe downturn was key to its decision to insure 260 billion pounds of risky assets with the UK government.

The deal, announced on Saturday, will limit losses if the economy deteriorates further, but may give Britain a stake of up to 77 percent in Lloyds. That dilution for shareholders sent the bank's shares skidding over 10 percent early on Monday, before a recovery underpinned by its reduced risk outlook.

Lloyds' comments about capital raised alarm as the regulator had signalled it expected lenders to run down capital and came as the bank's executives faced criticism for the takeover of HBOS, which is at the heart of most of its troubles.

The comments were seen as negative for Barclays, which is considering putting assets into the protection scheme.

"Whereas before the posture was that capital ratios could drift down towards the regulatory minimums as conditions worsened, the thinking now is that capital should be looked at in the face of a reasonably severe stress," said Lloyds Chief Executive Eric Daniels.

The Financial Services Authority said on January 19 that a previous UK recapitalisation plan was designed to give banks a decent capital buffer, which was expected to be run down as banks absorbed expected losses. It declined comment on Monday.

Lloyds has started meeting investors to discuss the plan, which shows policymakers are giving unprecedented support to try to get lending flowing again and restore confidence in the battered banking sector.

Lloyds shares closed up 4.1 percent at 43.7 pence, bouncing from an early low of 36p. A year ago they were worth about 450p.