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 ($370 billion) of risky assets with the UK government.

The deal, announced on Saturday, will give Britain a stake of up to 77 percent in Lloyds and sent its shares skidding over 10 percent on Monday as it will further dilute shareholders.

The bank's comments about capital raised alarm the regulator is imposing more stringent requirements and was seen as negative for Barclays , which is considering putting assets into the UK asset protection scheme.

Whereas before the posture was that capital ratios could drift down toward 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.

That's one of the impetuses behind looking at the appropriate amount of capitalization that's necessary and how much should be thrown into the scheme, he told analysts on a conference call.

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

Lloyds will start meeting investors on Monday 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.

By 0940 GMT Lloyds shares were down 8.1 percent at 38.6 pence, after an early low of 36p. Analysts welcomed the news of the risk protection but said it is more dilutive than expected and relatively expensive. Shares in Barclays, whose talks with the Treasury will intensify this week about whether it will put assets into the protection scheme, fell 9 percent, the biggest FTSE 100 faller.

The guaranteed asset protection scheme looks to be very thorough, in terms of virtually eliminating the risk of full nationalization... but also in terms of diluting the existing shareholders, said Bruno Paulson, analyst at Bernstein.

RISK REDUCTION

Lloyds will give Britain 15.6 billion pounds in non-voting 'B' shares in return for state-funded insurance against further losses on the assets.

The bank will also be responsible for the first 25 billion pounds of any losses, with the state bearing 90 percent of any subsequent loss.

Lloyds followed Royal Bank of Scotland in putting billions of pounds of risky assets into the asset plan.

The scheme will limit losses banks could suffer if the economy continues to deteriorate and more loans sour.

It will massively reduce the risks Lloyds carries on its books and lift the bank's core tier 1 capital ratio to 14.5 percent from 6.4 percent, which will be welcomed by investors.

The risk reduction is fairly extensive and makes it tough to see Lloyds requiring any further government help, Paulson said in a note. But he said the accompanying dilution limits the upside for shareholders.

The government's stake in Lloyds will rise to 65 percent from 43 percent if shareholders do not take up an offer to buy 4 billion pounds of shares currently held by the government.

Britain's holding could rise to 77 percent if the 'B' shares are converted to ordinary shares.

Lloyds chairman Victor Blank and CEO Daniels were expected to come under pressure for pushing through the takeover of HBOS, which made a near 11 billion pound loss last year and accounts for 83 percent of the risky assets being put in the scheme.

Daniels told Reuters on Saturday there had been no sign from investors they would object to the plan.

Many investors had already been angered by the deal, however, and the UK Shareholders' Association, which represents private investors, said shareholders were incandescent about what has happened, the Sunday Times reported.

Under the deal, Lloyds pledged to increase lending to homeowners and businesses by 28 billion pounds over the next two years.

(Additional reporting by Myles Neligan; Editing by Dan Lalor and Hans Peters)

($1 = 0.7030 pound)

United kingdom Royal Bank of Scotland Barclays