Bradford & Bingley's shares fell 18% yesterday after a US investor abandoned a scheme to rebuild the capital cushion of the UK's largest buy-to-let lender and its existing shareholders stepped in to foot the bill.

Standard Life Investments, HBOS investment arm Insight, the Prudential's M&G and Legal & General Investment Management were forced to intervene to rescue the bank's £400m capital raising after Texas Pacific Group (TPG), which was supposed to be providing £179m in return for a 23% stake, walked away.

TPG used a clause in its contract to abandon the deal after a downgrading of the bank's debt by ratings agency Moody's.

The bank has now decided to increase the amount it is raising from a rights issue to existing investors from £258m to the full £400m after costs. It wants to bolster its capital base amid signs that it is seeing rising levels of late payments on loans as the economy falters.

Investors will be offered 67 new shares for every 50 existing ones.

Yesterday's move sent Bradford & Bingley shares down 16% to 50p, below the 55p a share price it has retained for the rights issue that will continue to be underwritten by investment banks Citi and UBS.

Analysts at Dresdner Kleinwort said: "TPG's exit shows it does not feel the bank is worth 55p."

Resolution, which had sought to implement a rival fundraising deal, sent out strong indications that it would not be tempted to revive its scheme.

Events rattled confidence in the banking sector with Alliance & Leicester particularly hard hit. The company, which also announced a reorganisation of board responsibilities yesterday, closed down 12.4% at 255.5p.

HBOS, which is conducting its own £4bn fundraising, fell 2.8% to 271.5p, below the 275p at which it is offering new shares. RBS shed 3.2% to close at 206.25p, Barclays dropped 4.5% to 279p, and Lloyds TSB fell 2.2% to 299.25p. Even Asia-focused banks were hit. HSBC was down 2% at 754p and Standard Chartered was off 3.5% at 1396p.

The situation came about after Moody's downgraded Bradford & Bingley's un-secured and long-term debt ratings. The downgrade would have increased TPG's costs to finance the deal.

The agency highlighted the asset quality of the company's loans, namely the risk that borrowers will default. It suggested that the company will have to take further write-downs of holdings linked to the credit market.

Ironically, considering its findings threatened Bradford & Bingley's fundraising, the agency highlighted the company's capital raising as "critical".

"The new rating actions assume the execution of the rights issue," it cautioned.

Bradford & Bingley executive chairman Rod Kent, who postponed the extraordinary meeting to approve the fundraising by a week to July 14, said: "Bradford & Bingley continues to be well-funded and the capital raising will reinforce our position as one of the better capitalised banks and one of the leading mortgage and savings banks in the UK."

Rival ratings agencies Fitch and S&P maintained their ratings. The downgrade from Moody's also removes any hope that Resolution might come in with a less dilutive fundraising plan.

Clive Cowdery's intention to find a vehicle for consolidating the banking sector was predicated on it having an AA-rating, which Bradford & Bingley has now lost.

A spokesman said: "We are watching the banking sector to see how it develops alongside other financial services opportunities this summer."

Cowdery is understood to have identified 15 consolidation opportunities in the UK.

It has been a confusing time for Bradford & Bingley investors. As recently as April the company denied it needed to raise any cash. On May 14 it said it wanted to raise £300m. Then on June 2 it issued a profit warning, announced its chief executive was stepping down for health reasons and unveiled the enhanced £400m fundraising deal that included TPG.

Last week Resolution went public with its own plans to inject £400m into the company, but withdrew after being denied access to Bradford & Bingley's books.

Some analysts have started drawing parallels with Northern Rock, which was nationalised earlier this year following funding problems. Yesterday it was revealed that Northern Rock will not pay a dividend on £400m preference shares owned by the Treasury. The government wants it to focus on repaying some £24bn of loans it received from the Bank of England.

The challenge facing banks was highlighted in stark terms by the investment bank Goldman Sachs yesterday when analysts there said European banks need to raise 40bn to 90bn or withhold one year of dividends to boost their capital bases.