RBS and Barclays CDS tighten on funding reports

LONDON, Oct 7 (Reuters) - The cost of insuring the debt of UK banks Royal Bank of Scotland (RBS.L: Quote, Profile, Research) and Barclays (BARC.L: Quote, Profile, Research) against default fell sharply on Tuesday morning on reports of funding talks with the government.

Five-year senior credit default swaps on RBS were about 30 basis points tighter at 270 basis points and about 20 basis points tighter at 230 basis points on Barclays, a trader said.

That means investors have to pay 270,OOO and 230,000 euros to insure 10 million euros of the respective banks' debt against default.

Shares in RBS sank 30 percent, while Barclays lost 15 percent and Lloyds (LLOY.L: Quote, Profile, Research) lost 20 percent.

The credit trader said the move was based on speculation that the government is considering injecting capital in banks in return for equity stakes.

"It's more of an equity story, as it look like shares will be diluted, while a capital increase is credit positive which explains how the CDS has reacted," the trader said.

(Reporting by Natalie Harrison)