Both Barclays (BCS) and Royal Bank of Scotland (RBS), two major British banks, have denied reports that they are seeking capital injections from the British government. But RBS, which is continuing to pay the price for leading the $101 billion takeover of Dutch bank ABN Amro last year, saw its shares plummet almost 40% in New York trading on Oct. 7. RBS is one possible candidate for a rescue, though it says it has not requested one. It is understood that Barclays would not refuse a government demand that it take on additional capital.

The bank under the most pressure now is HBOS (HBOS.L), the largest British mortgage lender, whose shares fell more than 41%. That puts in question the bank's pending takeover by Lloyds TSB (LYG), one of the big four commercial banks. Prime Minister Gordon Brown has taken credit for helping to broker that deal when HBOS ran into trouble. It is unlikely that the British government will want the deal in which the Prime Minister takes such pride to come unstuck.

In addition, bankers privately acknowledge that they are talking to the government about options to boost their capital, reassure shareholders, and so forth. With the economic indicators turning sour, a government recapitalization effort could happen very soon. Press speculation has the British government imitating Warren Buffett by buying preferred stock, while also obtaining warrants so the British taxpayer would participate in any upside.

Rushing to Avert Panic All over Europe, governments are scrambling to put out fires in the banking system. There is little time to waste on devising grand European solutions. Markets sniff out weak banks, and worries about their solvency quickly translate into plunging stock prices and liquidity cutoffs. Panic isn't far away.

More government intervention seems certain, and it is likely that the rescues will combine a melange of measures. Denmark, Germany, Greece, and Ireland have already guaranteed deposits. The Netherlands has taken over operations of Fortis (FOR.BR), another victim of the toxic ABN Amro deal, under its jurisdiction. Some of the actions will be coordinated, but more will probably occur at the national or regional level as with the rescue of Fortis, Dexia (DEXI.BR), and Germany's Hypo Real Estate Holding (HRXG.DE) in recent days.

Paying back depositors and guaranteeing debts would be extremely expensive -- more than the gross domestic product. But governments are counting on their guarantees preventing actual runs on the banks. Stephane Deo, an analyst at UBS (UBS) in London, figures that recapitalizing the banks, as is being discussed in Britain, would be the more cost-effective solution. In the case of Germany, adding another 1% to Tier 1 capital [the most widely followed measure of a bank's financial strength] would cost 3.2% of GDP, he calculates -- expensive but much cheaper than the guarantee route. "The endgame of this financial crisis must include recapitalization, including nationalization," Deo says.