MICHAEL SETTLE, TORCUIL CRICHTON and IAN McCONNELL

UK banks last night challenged the Irish government over its promise to give 100% protection for savers, suggesting the move was anti-competitive.

Dublin has pledged all deposits at Irish banks will be safe in a bid to reassure citizens at a time of financial crisis. Last night it emerged that the Irish government may be forced to include foreign banks in its deal.

Finance Minister Brian Lenihan last night faced calls to extend the two-year protection to overseas financial institutions such as Ulster Bank and National Irish Bank. Ireland's Department of Finance said any formal applications from such banks for inclusion "would be considered".

However, the British Bankers' Association (BBA) said it was raising the issue with Ireland amid concerns that the move put UK banks at a disadvantage.

The protection offered is far more generous than the £35,000 worth of savings protected under current UK legislation.

Despite a move on the cards to increase the UK ceiling to £50,000, the Irish government's pledge has led to suggestions that customers are already moving money from UK banks to Irish ones to benefit from the 100% protection. A Bank of Ireland spokeswoman said anecdotal evidence suggested British savers were moving cash to the bank to take advantage of the guarantee.

Savers were also said to be moving their money to what they regarded as safer institutions in the UK such as Lloyds TSB and Abbey as well as to the Treasury-backed National Savings and Investments.

The BBA said: "We are taking up with the Irish government its moves to guarantee bank deposits as this has distorted competition, putting banks at a competitive disadvantage. The extent of the guarantee has clear consequences for firms competing to win retail deposits and, while we support proposals aimed at re-introducing stability to the financial markets, we need fair play for financial institutions across Europe."

Elsewhere, shares in Bank of Scotland and Halifax parent HBOS rebounded by 21% yesterday. However, they closed at a 29% discount to the value of Lloyds TSB's rescue takeover offer in spite of Prime Minister Gordon Brown expressing his confidence that the deal would go ahead and the emergence of Standard Life Investments as a supporter of the transaction.

This discount, although it narrowed from about 35% on Tuesday, signals City scepticism that the deal will go through on the current terms.

Lloyds TSB's offer, of 0.833 of its shares for every one in HBOS, last night valued the Edinburgh-headquartered bank at 208.25p per share or £11bn in total. HBOS's shares closed last night at 148.1p, giving it a stock market worth of only £7.8bn.

Rival bank shares also firmed as investors looked ahead last night to the expected US Senate approval of a $700bn bail-out. Barclays added 4% and HSBC 2%. Gains for Royal Bank of Scotland were less than 1%.

US politicians appeared confident the rescue deal would pass. A spokesman for George Bush said the President hoped to see "strong support for the bill".

Steny Hoyer, leader of the House Democrats, said: "The Senate thinks it has the votes and I think it probably will pass."

Meanwhile, fears grew that Britain was edging into recession with official figures showing manufacturing was now shrinking at the fastest rate since records began 17 years ago. Analysts suggested that the data will pile pressure on the Bank of England to cut interest rates.