Gordon Brown and Alistair Darling set out a radical £500 billion package today to restore confidence in the UK banking sector and break the crippling logjam in credit markets.

The three-part package includes committing up to £50 billion of taxpayer funds for a partial nationalisation of stricken banks, met from increased public borrowing and with political strings attached that would include reining in executive pay.

In addition, the Bank of England will pump at least £200 billion into the money markets under its existing Special Liquidity Scheme. The Government is also making a further £250 billion available for banks over the next three years to guarantee medium-term debt to help restore confidence and get banks lending to each other again.

The deal was hammered out in talks with banking chiefs that dragged on into the early hours. At a joint press conference in Downing Street, both the Prime Minister and Chancellor were keen to draw a distinction between their rescue plan and the $700 billion US bailout involving the purchase of "toxic" assets.

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The rescue is about saving capitalism, not replacing it with socialism

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Giving them more of our cash may not be enough

The Bank and the Treasury believe the move will benefit all banks but many bankers believe other measures will be needed

• British taxpayer to be tied into £50bn bank bailout

The taxpayer will pay in the end

Where will Alistair Darling find £50 billion in a hurry? The answer, inevitably, is from taxpayers

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"All these are investments being made by the Government, which will earn a proper return for the taxpayer," Mr Brown said.

"Remember, this is not the American plan. The American plan is to buy up the state assets by state funds. The £50 billion is to buy shares and therefore we will have a stake in the banks and we will get the upside in the appropriate cases from what we have done."

"Look at it another way," Mr Darling added. "If you didn't do anything, there would be a very significant cost to all of us as taxpayers."

A key element of the deal is a government-supported recapitalisation under which eight major lenders have agreed between them to raise their Tier 1 capital – the main measure by which regulators assess a bank's strength – by £25 billion between them.

The Treasury is offering to fund that recapitalisation, meaning a partial nationalisation and a dilution of existing stockholdings, as well as offering a further £25 billion to buy preference shares or PIBs – permanent interest-bearing shares.

But not all of the banks involved will take taxpayer cash to strengthen their Tier 1 capital. Both HSBC, the country's biggest banking group, and Standard Chartered, said today that they would not need public funds and only Royal Bank of Scotland said that it would do so.

The other lenders involved are Lloyds TSB, Barclays, Nationwide, Abbey (which is owned by the Spanish bank Santander) and HBOS (which is to be taken over by Lloyds TSB).

Describing the challenge facing policymakers, Mr Brown said that the global financial market had "ceased to function, putting in danger the necessary flow of money to businesses and families on which all of us depend in our daily lives". Accordingly, he added, officials in the Treasury, the Bank of England and the Financial Services Authority had been working for weeks on a rescue plan.

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