(Adds details from sources)
By Peter Griffiths and Sumeet Desai
LONDON, Jan 18 (Reuters) - Britain will guarantee "toxic debt" worth billions of pounds in a second bank bailout designed to boost lending and fend off a prolonged recession triggered by the worst economic turmoil in 70 years, people familiar with the matter said on Sunday.
The government is also likely to swap preference shares it
holds in Royal Bank of Scotland
Government officials spoke with bank chiefs throughout the weekend to hammer out a solution to a credit freeze that has crippled industry, small businesses and homeowners already struggling to cope with the downturn.
The Treasury said it will announce the plan before Monday's market opening, which is at 0800 GMT.
Prime Minister Gordon Brown, speaking to reporters in Egypt, where he was attending talks on Gaza, said: "We know the essential problem is the resumption of lending."
The package is aimed at clearing blockages in the credit pipeline and is designed to "get lending moving in the economy" to help families and businesses, Brown said.
Key parts of the bailout will include a huge state insurance scheme to guarantee billions of pounds of banks' bad assets, three people familiar with the discussions said. The Treasury will guarantee at least 100 billion pounds ($149 billion) of new lending, the Sunday Times said.
The state will swap up to 5 billion pounds of preference shares in RBS for ordinary shares, aiming to remove pressure on the bank to pay 12 percent annual interest on the preference shares, one of the sources said.
Britain also took preference shares in Lloyds Banking Group
Banks will have to identify their riskiest loans and could get insurance against losses above a certain level in exchange for a fee, one of the sources said.
The plan would also include government guarantees for mortgage-backed securities as recommended by a government sponsored review last year, and could be widened out to cover more types of assets.
The government is also looking to extend its credit guarantee scheme for banks which took state funds in October.
It is also likely to extend or create a new special liquidity scheme and no longer run down the loan book of government-owned lender Northern Rock, the source said.
Britain has been forced into a second rescue after a state injection of 37 billion pounds to recapitalise RBS, Lloyds and HBOS -- which has now been taken over by Lloyds -- last October failed to get credit moving again.
CONFIDENCE PLUMMETS
Confidence in banks has plummeted due to fears over the exact scale of their exposure to bad loans.
On Friday, shares in Barclays
Ministers have drawn up plans to nationalise fully RBS, the Sunday Telegraph said.
In an interview published on Saturday, Brown said banks must come clean over their bad debt to kick-start any recovery.
"One of the necessary elements for the next stage is for people to have a clear understanding that bad assets have been written off," he told the Financial Times newspaper.
Brown is eager to get banks to increase lending to businesses and households after a series of bleak figures on trade, unemployment and the housing market.
The former finance minister has seen his poll ratings fall in recent weeks, with some surveys suggesting voters are growing increasingly disillusioned with his handling of the economy.
Conservative leader David Cameron and his finance spokesman George Osborne regained their poll lead over Brown and finance minister Alistair Darling when people were asked which pair would handle the economy more competently.
Nine out of 10 of those polled said the British economy was in a bad state after a slew of bleak figures on unemployment, trade and house prices. (Additional reporting by Steve Slater in London and Keith Weir in Sharm el-Sheikh, Egypt; Editing by John Stonestreet, Richard Chang)