The government and the central bank will inject more than £100bn to the UK's banking system to provide funding support to financial institutions that will, in turn, ensure lending to businesses and consumers.
Speaking at his annual Mansion House policy speech to City bankers, Bank of England (BoE) Governor Mervyn King said Britain would launch a scheme to provide cheap long-term funding to banks that could thwart the "black cloud" of the eurozone debt crisis.
"The black cloud has dampened animal spirits so that businesses and households are battening down the hatches to prepare for the storms ahead," King said.
He also pointed out that the eurozone crisis is leading to a crisis of confidence in the country, as the gloomy growth outlook for the economy persists.
Britain's efforts to insulate itself from the dangers of a possible eurozone collapse, and to avoid a financial crisis similar to the one from 2007-2009 that resulted in the bailouts of its big banks, were evident from the speech of chancellor George Osborne.
"We are not powerless in the face of the eurozone debt storm. Together we can deploy new firepower to defend our economy from the crisis on our doorstep," Osborne said in his speech at Mansion House.
The coalition government has unveiled its White Paper on banking reforms. The reforms set out by the Treasury urge the banks to separate their retail and investment divisions to ensure more protection for taxpayers' money. The banks were also asked to keep more capital to safeguard themselves against bad bets.
The new cash 'firepower'
The BoE and finance ministry plan to launch the "funding for lending" scheme to offer bank loans with a maturity term of about three to four years lower than the present market rates. However, the support would be in exchange for lending commitments from the banks.
The plan is expected to support nearly £80bn of new loans and mortgages.
The BoE also has plans to activate the extended collateral term repo facility, which was launched in December to supply monthly £5bn tranches of six-month liquidity to banks.
King also indicated that the bank may restart its QE programme to complement the new scheme. The bank has already bought government bonds worth £325bn through the asset purchase scheme, which was stopped in May.
"With signs of a deterioration in the outlook, especially in world markets, the case for a further monetary easing is growing," King said.