Lloyds TSB is to merge with HBOS, creating a banking giant which will hold a third of the UK's savings and mortgage market.
Both firms' boards have agreed to a deal, at a price of 232p per HBOS share following talks.
The deal should calm uncertainty about the strength of Halifax-Bank of Scotland after a run on its shares.
The deal is set to be formally announced on Thursday morning, says BBC business editor Robert Peston.
The talks between the two banks were first reported HBOS in merger talks with Lloyds ...
Recession in UK 'is months away' ... by the BBC earlier on Wednesday.
Global turmoil
The credit crunch has wreaked havoc on some of the world's financial institutions in recent days.
- Barclays Bank is to buy some Lehman Brothers assets after the fourth-largest US investment bank filed for bankruptcy protection, dealing a blow to the fragile global financial system.
- The US Treasury stepped in with an $85bn rescue package to bail out AIG amid fears the group, once the world's largest insurer, could face collapse.
- Bank of America bought Merrill Lynch in a $50bn deal - making it the third top US investment bank to fall prey to the sub-prime crisis within six months.
- In Russia, trading on the country's main stock exchanges was halted after steep falls this week.
- Meanwhile, in the UK recent economic news has done little to lift the gloom, with unemployment rising once again as the number of job vacancies fell.
Fear of a run
Before the news broke, our business editor said the government had opted to push through the tie-up after HBOS voiced concerns that depositors and lenders had begun to withdraw their credit from the bank.
"There were growing concerns in the HBOS boardroom that a climate of fear was being created about its future, that could have led to a funding crisis - or a Northern-Rock style run, on steroids," he added.
The deal was negotiated at a very high level, with Prime Minister Gordon Brown telling Lloyds TSB chairman Sir Victor Blank that it would be helpful if Lloyds could end the uncertainty surrounding HBOS by buying it.
"It was not in the government's interest for there to be the faintest risk that it would have another Northern Rock on its hands," our business editor added.
Following the takeover, Lloyds chief executive Eric Daniels is expected to take the helm of the enlarged group. The future of HBOS chief Andy Hornby is unclear.
Competition concerns
Fears had been voiced that the proposed deal would face objections from competition watchdogs over the combined market share the enlarged group would have in mortgages and savings.
With 20% of the UK mortgage market, HBOS is the country's largest mortgage lender. Lloyds ranks fourth with an 8% share.
On the London market, HBOS shares have seen wild swings during the day on the London market, climbing as high as 220p and falling as low as 88p.
Shares in the lender eventually closed 19% lower, while Lloyds ended unchanged at 279.75p.
(BBC)
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