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The taxpayer is to become a major owner of the troubled New Star fund after several banks bailed it out in a debt-for-equity swap.

New Star has seen its share price plunge amid uncertainty over its future as it struggled under £260 million of debt owed to a syndicate of banks: HBOS, Lloyds TSB, Royal Bank of Scotland, HSBC and National Australia Bank.

However, a restructuring deal with the sydicate, led by HBOS, will see £240 million of the debt converted to equity.

HBOS, soon to be merged with Lloyds TSB and become part-owned by the government, will be the biggest shareholder in the fund.

The deal also includes the issuing of preference shares and other incentives to retain employees.

However, ordinary shareholders will be wiped out and the fund de-listed from the stock exchange, as the banks could end up owning 95 per cent of New Star.

John Duffield, chairman of New Star, said: "The board recognised the concerns of our clients regarding the level of our debt during these difficult times.

"We have therefore taken this radical step to address these concerns completely and with one stroke.

"The cost of this restructuring is regrettably a substantial dilution for ordinary shareholders, including me. However in current market conditions, we have to recognise that there is no other option to ensure the stability of the business."

Shares in New Star plunged 43 per cent on Monday as the fund admitted it was in talks with its banks.