Despite attempts by global policymakers to improve liquidity and restore stability after the weekend rescue of U.S. bank Bear Stearns, UK banks remain under pressure with rising funding costs adding to the threat of a UK economic slowdown and more losses on risky U.S. assets.
HBOS, Britain's biggest mortgage lender, bore the brunt of the rumours, with its shares plunging 17 percent to a record low of 398 pence at one point.
HBOS, owner of the Halifax brand, dismissed the speculation, saying it had an "exceptionally strong balance sheet" and continued to access wholesale funding. Its shares pared earlier losses but still closed down 7 percent at 446.25p.
The Bank of England, which has come under fire for failing to react quickly enough to the near collapse of Northern Rock six months ago, took the rare step of commenting on the rumours.
"No meetings have taken place or been scheduled to discuss problems with any institution in the UK," a Bank spokesman said.
The financial services regulator, which has also faced criticism over the Northern Rock debacle, confirmed an earlier Reuters report that it would probe the latest share sell-off.
"We will not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumours and dealing on the back of them," the Financial Services Authority (FSA) said in a statement.
Authorities are concerned that speculators can benefit from wild gyrations in share price and spread false information. Investors can profit by selling shares "short" before buying them back later.
"With panic still gripping the markets, investors seem to be attaching more credence to the scaremongers than would be the case in more stable times," said Martin Slaney, head of derivatives at GFT Global Markets.
Shares in other banks, including Alliance & Leicester and Bradford & Bingley, were also hit by the rumours. Lloyds TSB was cited as facing problems, but the bank said it was funding its operations strongly and it clawed back an early 3 percent fall and ended higher.
Policymakers showed they have an increasingly watchful eye on the situation.
