Royal Bank of Scotland was the biggest victim on another day of turmoil for banks amid mounting speculation that the Government is set to spend billions on a taxpayer-funded rescue of the ailing sector.

RBS was down 40% at one point - with big falls for HBOS, Barclays and Lloyds TSB - following crisis talks with Chancellor Alistair Darling on Monday night.

But in an attempt to calm market nerves, RBS said: "Contrary to press speculation, RBS did not make a request to Government for capital."

Meanwhile, Iceland nationalised its second-biggest bank Landsbanki - leaving UK savers in limbo as its Icesave online website was frozen.

The wider FTSE 100 Index was 2% higher after Monday's 7.8% slump - the biggest since Black Monday in October 1987 - as commodities bounced back slightly from the fall and oil prices rose.

But attention was firmly focused on banks, with RBS - also downgraded by investment ratings agency Standard & Poor's - later down 22% after its denial.

The bank's stock slumped after Sir Fred Goodwin and his rival bosses at Barclays and Lloyds TSB met Chancellor Alistair Darling on Monday night - with a possible capital injection for the sector reportedly on the agenda. The concerns caused a fresh spike in money markets as fearful banks refused to lend to each other.

Meanwhile, New York mayor Michael Bloomberg said that international leaders must work together to tackle the global financial crisis.

After breakfast talks with Prime Minister Gordon Brown in Downing Street, Mr Bloomberg criticised the unilateral actions of some governments.

Referring to Mr Brown, the New York mayor said: "He's got a tough road to hoe, representing the UK, representing Europe, representing the world. All of these leaders have to work together. This is a crisis that no one country can solve on their own."