The Conservatives have called on city watchdogs to conduct in inquiry into the the government's handling of the collapse of Railtrack.

The shaow chancellor, Michael Howard, said the decision to put the firm into administration could have broken financial services regulation. Howard said he was writing to the Financial Services Authority chief, Howard Davies, to ask whether the body intended to probe the situation surrounding Railtrack.

"There are a number of ways in which there may well have been breaches of the regulations. It is perfectly possible that investors will be able to say with some considerable justification that they have been misled following the government's announcement in April that it would make £1.5 billion available, and its decision now to renege on that commitment," said Howard.

He said the goverment had sent shockwaves through the private sector by its actions. "What we have seen is naked confiscation of the worst kind, Even more fundamentally, the capital markets have learned to their cost that they can't trust the government. That is going to have very far reaching ramifications on the ability of the government to bring private sector money and private sector resources into the public services, the great public service infrastructure projects that matter so much for the quality of life in our country," he said.

John Prescott, the deputy prime minister and a former transport minister, defended the government against Tory criticism.

"The difficulties that Stephen [Byers] is faced with, and indeed the taxpayer as well, and what I found while I was dealing with Railtrack, is you never could be sure how much they were going to be asking for," said Precott. "How can you have confidence in any body that actually keeps coming forward with those kind of increases, and that is the great difficulty about Railtrack."

Byers met with Railtrack chiefs on Friday amid growing anger at the government's decision to let the company go to the wall without putting in place a compensation plan foe shareholders.

The talks came as Railtrack bosses called on the government to honour its commitment to give the company rights over the channel tunnel rail link.

Speaking before the meeting, Steve Marshall, the company's chief executive said the purpose of the meeting was to "talk to the secretary of state about the Channel Tunnel Rail Link principally.

However, it was widely expected that Byers will reject the demands. He said it would be "wholly inappropriate" for taxpayers' money to be used to pay shareholders in the collapsed firm.

In a new twist, the German bank West LB said on Friday that it had contacted ministers to discuss the future of the company. The bank, which is state-owned, confirmed it had made a "preliminary approach" with a view to making a possible offer for the firm which was placed in the hands of administrators last Monday.

A breakthrough was reached last week, when Railtrack reached a deal with government officials, allowing the company to return £370 million of previously frozen funds to shareholders.

Following the decision by Byers to seek a court order placing Railtrack in administration, all funds, including the £370 million in question, had been frozen while the separate assets and liabilities of Railtrack plc and Railtrack Group were identified.

Only Railtrack plc had been placed in administration, having been considered to be insolvent.

Railtrack bosses had argued that the £370 million belonged to Railtrack Group and had threatened the government with legal action in an attempt to recover the funds from the company's HSBC account.

A meeting between Railtrack Group directors and government officials reached agreement on the return of the £370 million when a replacement non-profit making company had been formed. The government is also to meet Railtrack Group's short term cash requirements.

The £370 million would fund a shareholder compensation package of 70 pence per share.

However, Railtrack says it is seeking an increase in shareholder compensation to £3.60, a level in excess of the £2.80 at which the company's shares were suspended.

Defending his move, Byers said the steps to put Railtrack plc in administration had been "a consequence of failure to manage costs over a number of years".

"Taxpayers' money, which would otherwise be spent on key public services such as schools and hospitals, as well as railways, should not be used to compensate for the poor performance of private sector companies.

"We will assist in identifying ways in which money belonging to Railtrack Group might be made available to shareholders but we will not provide extra funding from the taxpayer to compensate shareholders," said Byers.

The turn-around by Byers followed reports that the move would damage the government's ability to raise private capital for future transport projects. The Liberal Democrats said Labour was "botching" the job of replacing Railtrack.

Don Foster, the Lib Dem transport spokesman, said: "It is amazing that the government sprang administration on Railtrack without making detailed provisions for shareholders. The Conservatives' privatisation was botched. Now Labour appears to be botching a sensible solution to Railtrack's financial woes."

Foster said Railtrack should have been given more time to turn itself into a public interest company. "But there can be no doubt that Railtrack had to change."

A spokeswoman from the RMT union said: "RMT's position is quite clear. We have always been against privatisation. We believe any profit should be ploughed back into the industry and not into shareholder's pockets."