HBOS, which last month agreed to be taken over by rival Lloyds in a government-brokered deal, welcomed the plan.

"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."

HBOS was the biggest sector loser on the market on Tuesday, losing 40 percent of its value, but was up 27.7 percent by 8:15 a.m.

Seven banks -- Abbey, Barclays, HBOS, HSBC, Lloyds TSB, Royal Bank of Scotland and Standard Chartered -- and the country's largest building society will take part in the government's recapitalisation scheme.

They have committed to increase their total Tier 1 capital by 25 billion pounds in total.

"In order to facilitate this process the government is making available 25 billion pounds to be drawn on by these institutions if desired to assist in this process as preference share capital or PIBS (permanent interest-bearing shares)," the Treasury said in a statement.

It said it was also willing to help raise ordinary equity if requested to do so.

"In addition to this, the Government stands ready to provide an incremental minimum of 25 billion of further support for all eligible institutions," it said.

In return the government will require banks to meet certain terms and conditions that will include banks making commitments to support small businesses and home buyers and to deal with what many see as unfair pay deals for bank executives.

OIL WHEELS

In an effort to get banks lending to one another again, the Bank of England will make at least 200 billion pounds available under its Special Liquidity Scheme and conduct three-month sterling and one-week dollar auctions for three months against a wider range of collateral until markets stabilise.

The government will also issue guarantees of short and medium-term debt to banks who commit to raising their Tier 1 capital.

"The proposal envisages the issue of senior unsecured debt instruments of varying terms of up to 36 months, in any of sterling, U.S. dollars or Euros," it said.

"The Government expects the take-up of the guarantee to be of the order of 250 billion pounds, and will keep this under review alongside ongoing monitoring of capital positions and lending volumes."

Darling and Prime Minister Gordon Brown will hold a press conference later on Wednesday.

Governments around the globe, from Iceland to South Korea, are fighting to unfreeze lending and borrowing brought to a halt by fears of hidden losses in financial institutions.

(Writing by Jodie Ginsberg, editing by Kate Kelland and Will Waterman)