The U.S. government may end up holding as much as 40 percent of Citigroup's common stock, the Wall Street Journal reported on its website, citing sources familiar with talks to shore up the ailing lender.

But Citigroup executives hope talks with U.S. officials will result in a government stake closer to 25 percent, the Journal reported. The administration of President Barack Obama has not indicated whether it supports the plan, the report said.

A source familiar with the situation told Reuters that talks were ongoing between Citi and regulators that could result in the U.S. government increasing its stake in the bank.

The lender is discussing with U.S. officials a scenario under which a substantial portion of the $45 billion in preferred shares held by the U.S. government, amounting to a 7.8 percent stake in Citigroup, would convert into common stock, the Journal reported.

The plan would not cost further taxpayer money, but other Citi shareholders would see their stakes diluted and the government would have much larger influence over Citi.

The discussions reflect growing concerns that Citi and other big U.S. banks could be swamped by losses amid the housing crisis and swooning economy, the Journal said.

The New York Times reported on its Website that the plan being contemplated at Citi could pave the way for similar moves at other big banks.

The U.S. Treasury did not immediately reply to a request for comment.

Separately, the Financial Times said Citigroup was pressing the U.S. government to agree on a new capital injection that would increase the authorities' stake in the bank to about 40 percent, but stop short of outright nationalization.

U.S. stock futures turned positive and Treasuries fell after the reports on Monday.

It's a sign of relief that the move at least removes some of the uncertainty around the banking sector, said Tony Morriss, senior markets strategist at ANZ Investment Bank, in Sydney.

They are certainly moving much faster this time and it can be taken as a commitment that some banks are too big to fail and the economic consequences too bad to contemplate.

Shares in Citigroup and Bank of America tumbled for a sixth straight session on Friday amid fears the U.S. government could nationalize the two banks, wiping out shareholders' investments.

The White House later said President Obama favors a privately held banking system.

STRESS TESTS AHEAD

In coming weeks, the U.S. Treasury is expected to subject up to 25 banks, each with assets exceeding $100 billion, to stress tests to decide which need additional capital.

Citigroup officials hope to persuade private investors that have bought preferred shares -- including the Government of Singapore Investment Corp (GIC), Abu Dhabi Investment Authority and Kuwait Investment Authority -- to also convert their preferred shares into common stock, the Journal reported.

Until most of the news is known, there will be a lot of volatility and probably a downward trend in the equity market because we don't know how much pain for investors government measures will induce, said Dariusz Kowalczyk, chief investment strategist with SJS Markets in Hong Kong.

By which I mean, will current holders of bank equity lose everything, or most?

The Financial Times said Citi insiders expect a decision on the company's future in the coming weeks, but warned it would have to come earlier if its shares fell again this week.

Citi could also try to raise fresh equity with a public share offering, the FT said. The aim would be to keep the government stake to no more than 40 percent, or at least below 50 percent, it said, citing people familiar with the plan.

Citi stock has dropped 71 percent so far in 2009.

(Editing by Ian Geoghegan and Jean Yoon)

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