Taxpayers could be liable for £200bn in toxic bank loans

Plan to use public funds to underwrite debt in a bid to save high-street lenders ahead of more bad news

British taxpayers could face a £200bn liability for bad bank debts under government proposals for a huge "insurance scheme" to ease the burdens of high-street lenders.

Whitehall officials confirmed last night that a plan to use public funds to underwrite the toxic loans taken on by British banks in recent years was under discussion as Gordon Brown tried another rescue plan to kick-start the economy.

The "safety net" proposal, being hammered out by the Prime Minister, the Chancellor, Alistair Darling, and bank bosses, would require institutions to identify their most troublesome loans and pay into a state-sponsored insurance scheme. Although the liabilities would still be owned by the banks, taxpayers would ultimately have to pick up the tab for losses greater than an agreed amount.

Details of the scheme emerged as key figures within Government distanced themselves from claims that ministers were planning to establish a toxic bank that would assume control of £200bn of bad debts.

The extra protection from huge customer debts that might otherwise have to be written off is designed to offer banks more security and encourage them to begin lending more to business and individual clients.

Mr Brown said any recovery from the worst economic turmoil in 70 years will depend on banks first writing off toxic loans to try to restore confidence in the financial system. He is keen to get banks to increase lending to businesses and households after a series of bleak figures on trade, unemployment and the housing market. But he is also increasing pressure on banks to reveal the extent of rash loans made in the past. Despite a £37bn bank bailout last year and record rate cuts, banks remain unwilling to increase lending as they try to boost balance sheets and avoid risk.

The latest rescue plan comes amid growing concern that lenders are about to unveil losses for 2008 that will send shockwaves through the market and hold back recovery still further.

The Royal Bank of Scotland (RBS) is rumoured to be preparing to reveal about £20bn of losses, which would be the biggest corporate loss ever in Britain. HBOS's bad debts, meanwhile, are thought to be so serious that the Government will press for the Lloyds Banking Group to come under state control.

Details of Labour's latest bail-out plans, which could be announced as early as tomorrow, came as Mr Brown stepped up his rhetoric over irresponsible lending. New balance sheet figures for some big lenders, including Barclays, RBS and HSBC, showed that 80 per cent of their loans were with overseas individuals and firms.

In a statement to reporters in Downing Street, Mr Brown said: "It is the exposure of British banks to international losses that is the biggest problem that we face."

Senior Whitehall sources said the talks had still not produced a final agreement, on the terms of the assistance or the amount of Government money involved. One Government source close to the negotiations said the "toxic bank" proposal was not on the cards – at least for the moment – while the insurance scheme had emerged as a favoured option.