Chancellor Alistair Darling has announced a wide-ranging package of measures to tackle the crisis in the financial system.

The Treasury will make £50 billion available for banks to strengthen finances rocked by the credit crunch.

It will also provide - for a fee - guarantees of around £250 billion on loans between banks, which it hopes will ease the pressure in frozen money markets.

The Government meanwhile has expanded the size of its Special Liquidity Scheme - which allow banks to swap risky assets for safer Treasury bonds - to £200 billion and is accepting a wider range of collateral in its funding auctions.

The Government has been forced to act now as the banking system is arguably facing its biggest crisis since the Great Depression. Lending between banks has virtually ground to a halt because of the contagion which has spread across the globe since the credit crunch hit in August 2007.

Since the collapse of Lehman Brothers in September the crisis has reached a new pitch with nationalisations and bail-outs in Europe, the US and the UK's Bradford & Bingley.

It is hoped that the extraordinary measures will provide the capital boost needed and help restore confidence to get banks lending to each other again.

But the Government is demanding that in return for the public-backed cash injection, banks must cap executive pay and shareholder dividends and commit to supporting lending to homebuyers and small businesses.

The Prime Minister told a Downing Street news conference: "Extraordinary times call for the bold and far-reaching solutions that the Treasury has announced today.

"Our stability and restructuring programme is comprehensive, it is specific and it breaks new ground.

"This is not a time for conventional thinking or outdated dogma but for the fresh and innovative intervention that gets to the heart of the problem."

The Prime Minister said the recovery plan would be funded through increased borrowing but insisted taxpayers would "earn a proper return".

"All these are investments being made by the Government which will earn a proper return for the taxpayer," he told reporters.

"This support is on commercial terms. We expect to be rewarded for the support we provide."

Asked if taxes would rise to pay for the package, he said: "This is initially met by borrowing.

Chancellor Alistair Darling rejected criticism from some quarters for failing to act more quickly in the face of this week's market meltdown, in which some major British banks have seen their share prices more than halved as the City waited for the details of a rescue plan. Pointing toward the United States, where a plan was rushed in front of Congress, he said Britain preferred to consider its options.

“It takes time to get the thing right,” he said.

Eight UK banks and building societies - including RBS, Barclays, HBOS, Lloyds TSB and Nationwide - have signed up to an initial £25 billion scheme.

Reaction to the plan

Commenting on the announcement, Mervyn King – Governor of the Bank – said: "A major recapitalisation of the UK banking system of at least £50 billion is a necessary condition for regenerating confidence in the financial system. The recapitalisation, further liquidity support from the Bank of England and the new guarantee scheme amount to a significant step forward in resolving the present crisis".

George Osborne, shadow chancellor commented: “We must make sure that any support from the taxpayer is used to help save small businesses from closure and enable families to stay afloat, not to pay the bonuses of bankers.”

Nick Clegg, Liberal Democrat leader: “There can be no doubt that today marks a fundamental shift in the way we view banks and, in turn, the obligations banks have to the public must change for good: they must serve the public interest as well as their own commercial interests.”

Sir Fred Goodwin, the Royal Bank of Scotland chief executive said: “These are a substantial and tangible demonstration of the Government’s commitment to ensuring the stability of the financial system.”

John Varley, chief executive of Barclays: “The package addresses the most significant issues in the market, namely confidence in the strength of the banking system and the working of the money markets.”

“Barclays commits to participating in these measures in ways which will protect the interests of our shareholders and customers, and benefit the broader financial system.”

David Kern, economic adviser at the British Chambers of Commerce, said he welcomed the "radical measures" taken by the Government to restore stability but called for an interest rate cut and lower business taxes.

"Given the erratic mood of volatility in the financial market there remains clearly a risk of renewed speculative attack," he added. "The current financial turmoil must not be allowed to damage the real economy. The vital flow of finance to businesses and consumers must be maintained at all costs."