The so-called campaign to "save Bank of Scotland" was dealt a blow yesterday when a second major institutional shareholder said it was backing the takeover of HBOS by Lloyds TSB.

Legal & General, which would own 5% of the combined group, said the deal would create a "stronger bank", adding to support already expressed by Edinburgh neighbour Standard Life Investments.

A group of Edinburgh business figures including Sir Tom Farmer is lobbying for a re-think of the deal, but L&G's chief executive, Tim Breedon, said: "A combination of Lloyds/HBOS through an all-share merger to create a stronger bank is probably desirable, given current difficult circumstances."

HBOS has now said it expects to post documentation to its shareholders in mid-November, and to seek approval for the deal and the capital-raising at a general meeting in mid-December. It said: "HBOS expects that the acquisition and capital raisings will be completed in January 2009."

Shane O'Riordan, spokesman for HBOS, told The Herald this week that the government's capital injection was "entirely dependent on the deal being completed".

Colin McLean, managing director of SVM Asset Management, commented that the terms of the deal had already shifted twice, adding: "I think the government should revise it back again."

He said Lloyds had been weakened by "a lot of late cycle lending" and added: "The government seems to have made its decision on the basis of the respective managements".

O'Riordan, however, said there was no question of a re-think. "We need to be masters of our own destiny, we should not be reliant on the government and nor should the taxpayer want that, and the best form of self-help is for us to do this deal. This is the right deal for all our stakeholders, irrespective of where they are in the UK."

He added: "The era of high liquidity is over and we are moving into a different world."

On government claims that lending must return to 2007 levels, banking sources point out that both Scottish banks have been over-dependent on the wholesale markets to fund their lending growth since the beginning of the decade, and smaller businesses were now inevitable.

One said: "The Royal is going to be radically reduced in size, because liquidity risk remains in place." He estimated that "Bank of Scotland" on its own is funded only 20% by its deposits.

McLean agreed that the banks had allowed lending growth to outstrip underlying asset growth by 30% to 40% since 2000, and the Royal had also made available "a very high level of facilities".

Bellway, the UK's third-biggest housebuilder, warned yesterday that the disappearance of HBOS could restrict the flow of mortgages for new build developments.

HBOS ended down 4.125p at 80p, or 15p adrift of the value of the Lloyds offer, while Royal Bank rose 3.6p to 68.6p.