Barclays emerged as a potential buyer of some of felled investment bank Lehman Brothers' assets, as the financial sector carnage spread on fears American International Group could be the next to fall.

Barclays, the UK bank that pulled out of emergency talks to save Lehman over the weekend, is in talks to buy the investment bank's core US broker-dealer business, people familiar with the matter told Reuters on Tuesday.

But concerns intensified that AIG, once the world's largest insurer by market value, could be the next victim after a ratings downgrade, causing a rout in stock markets already battered on Monday after Lehman sought bankruptcy protection.

"We expect near-term weakness for the European banks as markets digest the systemic consequences of the failure ... we are undeniably more cautious following the weekend's events," Keefe, Bruyette & Woods said in a note.

Leading European stock indices were down between 1.4 and 2.2 per cent in morning trading. The Dow Jones Stoxx banking index was 3 per cent weaker by 4:09 a.m. EDT. UBS fell 9.6 per cent, HBOS lost 11.5 per cent, and Barclays was 2.9 per cent lower.

AIG's illiquid shares on the Frankfurt stock exchange were 4.8 per cent off.

Asian share markets, many of them closed for a holiday on Monday, tumbled as investors absorbed the weekend's dramatic events on Wall Street, where Merrill Lynch agreed to be sold to Bank of America for $50 billion.Shares in AIG plunged nearly 61 per cent on Monday and the US Federal Reserve hired investment bank Morgan Stanley to review options for the firm, a person familiar with the situation said on Monday.

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