The country's second biggest bank is planning a multi-billion fundraising bid to shore up its balance sheet, according to reports.

Royal Bank of Scotland is understood to be preparing a rights issue worth anything between £5bn to £12bn after being hit by bad debts amid the credit crunch.

A rights issue involves the creation of new shares which are offered to existing shareholders, often at an attractive price.

The speculation will hit the embattled banking sector and experts say bank shares could suffer on the stock market.

Plans by Merrill Lynch to axe 4,000 workers have prompted fears of sweeping job cuts in the city.

Shares have been buoyed by hopes of a Government-backed solution to the ongoing crisis in credit markets, but news of a possible rights issue at RBS is set to fan fears over the health of the sector.

Matt Buckland, trader at CMC Markets, said: "While RBS may not have to turn to the Bank of England for support, a rights issue would see a dilution of its shares and it's not a sign of good news for the sector.

"If RBS announces a rights issue and it is taken up by investors, then we could see other banks follow suit."

RBS shares opened nearly 1% lower, but quickly recovered in early trade.

RBS has refused to comment on any planned rights issue, saying that it "notes recent speculation about a possible rights issue".

It added: "RBS confirms that its Interim Management Report covering trading performance and capital will be made next week."

RBS, which owns high street bank NatWest, is the latest bank to be at the centre of rumour over fundraising moves.

Mortgage bank Bradford & Bingley saw shares sink to all-time lows earlier this week after reports that it was plotting a rights issue to raise vital funds, despite strong denials from the firm.

Fellow lender Halifax Bank of Scotland also experienced dramatic share price falls on the back of funding rumours less than a month ago.

RBS is thought to be planning to announce a rights issue at its annual general meeting next week.

Copyright © PA Business 2008