Britain's largest banks are to be part-nationalised after the government took the momentous decision to pump tens of billions of pounds of public money into the sector to avert a banking collapse.

The move came as central banks around the world announced a co-ordinated cut in interest rates in response to mounting fears about the impact of the financial crisis on the world economy. The US Federal Reserve, the European Central Bank, the Bank of England, and the central banks of Canada, Switzerland and Sweden and the United Arab Emirates all cut their main lending rates by 0.5 percentage points.

Under the UK bank rescue, the government is to put up to £250bn into the banking system in an effort to keep banks lending. It will also offer a guarantee to banks issuing medium term debt, which could mean backing a further £250bn of bank borrowings. But it is likely to demand dividend cuts and the end of big bonuses at the banks in return.

The plan, announced by the Treasury on Wednesday, will initially see seven leading banks and the Nationwide Building Society apply for £25bn in permanent capital to raise their Tier One capital ratios, with a further £25bn available as a stand-by and for other eligible institutions. The banks have agreed to conclude their recapitalisation by the end of the year.

The banks involved are Abbey, now part of Santander of Spain, Barclays, HBOS, HSBC, Lloyds TSB, Royal Bank of Scotland and Standard Chartered as well as Nationwide. Other UK banks and building societies are invited to apply for the scheme as well.

Bank stocks were mixed in volatile London trading. Lloyds TSB rose 0.9 per cent to 227½p while its merger partner HBOS jumped 48 per cent to 138.8p. RBS, which fell almost 50 per cent in the previous two sessions, was 24 per cent higher at 112p, turning back from losses of over 10 per cent. HSBC fell 4.6 per cent to 859p. Barclays was 5.5 per cent lower at 264.3p, off wider losses of 17 per cent, and Standard Chartered lost 11 per cent to £11.65.

Referring to "extraordinary market conditions", the Treasury said the Bank of England would provide at least £200bn under its special liquidity scheme - under which banks can swap illiquid loans for risk-free government securities - "until markets stabilise".

"The Bank of England will take all actions necessary to ensure that the banking system has access to sufficient liquidity," the Bank said. "In its provision of short-term liquidity the Bank will extend and widen its facilities in whatever way is necessary to ensure the stability of the system."

The Bank added that until markets stabilise, it would continue to conduct auctions to lend sterling for three months and also to lend US dollars for one-week periods against a wider range of collateral. It will review the size and frequency of those auctions as necessary.

The government will also, for a fee, guarantee new short and medium term debt issues by the banks to help them refinance wholesale funding obligations as they fall due. It said it expected the take up of this guarantee to be of the order of £250bn.

In return for the new permanent capital the banks will be required to provide "full commitment to support lending to small businesses and home buyers", the Treasury said.

In talks with the banks, the government insisted that the terms and conditions of the new funding would "appropriately reflect the financial commitment being made by the taxpayer." The government will also take into account "dividend policies and executive compensation schemes".

The extra capital will probably come in the form of preference shares or other permanent interest bearing shares. However, the Treasury said it would also assist in the raising of ordinary capital if requested to do so.

The government said the measures were designed to "ensure the stability of the financial system" as well as protecting savers, borrowers and businesses.

The massive public bail-out comes after a day of turmoil on the London stock exchange on Tuesday, where shares in RBS fell 39 per cent to add to a 20 per cent tumble the day before. HBOS fell 41 per cent.

Faced with an intensifying banking crisis, prime minister Gordon Brown sanctioned moves for the taxpayer to recapitalise Britain's leading banks in an effort to restore confidence in the system and to allow them to start lending again.

The rescue is being presented as part of a wider attempt to reform markets and is expected to include a call to the banks to show responsibility over remuneration for bosses, now that the taxpayer has a direct stake.

Mr Brown told a press conference on Wednesday that there had been a "a failure of responsibility on the part of the banking system". He described the scheme as a "far more comprehensive programme than people had expected", offering "short term, medium term and long term security of funding".

Alistair Darling, chancellor of the exchequer, said the rescue package was the start of a solution to the logjam in the bank lending system, and did not rule out further action.

"We will do whatever it takes," he told Sky television on Wednesday. "I think it is very important that governments across the world do that. It's a crucial part of what we need to do here. It's not the only thing, but it's a crucial step forward."

Mr Darling, who will make a Commons statement later on Wednesday, wanted more time to form a full package but was forced to act by the market chaos and by circulated reports that banks wanted an injection of public money.

Officials apparently worked through the night to finalise the scheme so that an announcement could be made before the London stock market opened on Wednesday morning. Even so, many of the details have yet to be thrashed out, and banks will have to engage in negotiations with the government to agree how much capital they require.

At £50bn - roughly equal to £2,000 per taxpayer - the recapitalisation of the banks would more than double Britain's planned public borrowing this year, pushing public sector net borrowing close to £100bn and more than 6 per cent of national income, worse than any year since 1994-95.

The recapitalisation will deliver a huge boost to the banks' core Tier One capital - the preferred measure of balance-sheet strength. This is expected to give the market greater confidence about the banks' ability to absorb future losses.

However, the government's move has a broader significance because it will also send a strong signal to the banks' creditors that they are, in effect, protected from future losses.

Concerns about losses among creditors, triggered by the collapse of Lehman Brothers, the Wall Street bank, are the main reason why banks have recently struggled to access the funding markets.

The government said it had informed the European Commission of the plan, and was in talks with the governments of other countries about extending the proposals internationally.

Although HSBC is included in the list of eligible institutions, this refers to its UK subsidiary, not its holding company. HSBC said its UK unit would observe the requirements on Tier 1 capital but would do so from its own resources and had "no current plans" to participate in the scheme.

HBOS, the UK's largest mortgage lender which is currently being taken over by Lloyds, said: "The government's announcement represents a very real and serious intention on the part of the authorities, following consultation with the banking industry, to bring stability and certainty to the UK banking system. HBOS believes that this initiative is very much in the interests of its shareholders and customers."