The government will not underwrite Lloyds Banking Group’s planned rights issue, potentially compounding the challenge for the partly state-owned bank to raise enough capital to wriggle free of the toxic asset insurance programme.

Although the government, which owns 43.5 per cent of Lloyds, is thought likely to participate in the planned rights issue, officials insist that Alistair Darling, chancellor, has yet to decide formally. However, people involved in the process said that the government would definitely not underwrite the cash call, and so not make a commitment to mop up unbought shares.