LONDON (Reuters) - British bank Lloyds TSB (LLOY.L) is in merger talks with the country's biggest mortgage lender HBOS Plc (HBOS.L), a person familiar with the matter said on Wednesday.

News of the talks surfaced after HBOS shares were battered for a sixth consecutive day amid mounting fears about its funding position as the credit crunch has raised the cost of borrowing. The news sparked a rally in its shares.

The source declined to provide details on the stage or details of the talks.

Lloyds and HBOS declined to comment.

The BBC said the two banks were in "advanced" talks and under the deal HBOS shares would be valued at nearer to last week's closing price of 300 pence than their current level.

By 4:50 a.m. EDT HBOS shares were up 6 percent at 191 pence, valuing the bank at 10 billion pounds ($17.9 billion), after slumping over 50 percent earlier to trade at 88p. Lloyds shares were up 5.5 percent at 295p, valuing it almost 17 billion pounds.

(Reporting by Steve Slater, Kate Kelland and Lorraine Turner; Editing by Louise Ireland)

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