Alistair Darling is ready to hand over up to £5bn of taxpayers' money to the part-nationalised Lloyds Banking Group in order to shore up its finances.

Lloyds, 43% owned by the taxpayer, is seeking £25bn of extra capital so it can escape the multibillion-pound cost of the government's toxic asset insurance scheme. Selling new shares worth up to £5bn to the Treasury is part of the complex plan currently being considered by the regulators.

Any cash injection would follow the £17bn poured into Lloyds after its rescue takeover of HBOS last year when the collapse of Lehman Brothers sent the financial markets into a tailspin.

Lloyds has managed to repay £3bn but is now asking the taxpayer for more cash at a time when concerns over the budget deficit have led both major parties to promise severe cuts in public spending.

The move is likely to be seen as another climbdown by the government in its treatment of banks that are preparing to pay their staff millions of pounds in bonuses on the back of booming markets.

The Wall Street bank JP Morgan Chase kicked off the latest bank reporting season by announcing profits of $3.6bn in the past three months, figures likely to be matched today by Goldman Sachs when it reports third-quarter results. Goldman bankers are on track to have a bonus pool of $22bn by the end of the year – an average payment of more than $700,000.

The Dow Jones industrial average yesterday closed at 10,015 as it continued its strong rally from a low earlier this year of 6,470. The FTSE 100 index was up more than 100 points in London.

Negotiations between Lloyds and the government are still continuing and no decision has yet been made by the regulatory authorities, including the Financial Services Authority, about the viability of the bank's plan. The final deal is expected to be announced within the next few weeks. The government must also win the approval of Brussels regulators, who have been scrutinising the UK's plethora of bank rescue measures to check whether they comply with EU state aid rules.

The extra investment being demanded by Lloyds is part of its concerted effort to avoid participation in the government's asset protection scheme, which was announced in January when the future of the banking system was still not assured.

The scheme was intended to convince the City that Lloyds and Royal Bank of Scotland would not be crushed by bad loans as customers halted repayments when the recession deepened. Nine months later, the details of the scheme are yet to be agreed and Lloyds is determined to escape paying a hefty premium for the government to insure its toxic assets because it believes its losses have peaked.

Lloyds plans to raise around £11bn from its investors in the financial markets with the balance coming from debt restructuring and a sale of assets. To maintain its shareholding of 43%, the government would have to stump up about £5bn of that sum. But the chancellor is demanding a fee from Lloyds of an estimated £2bn, which would be set against the government's subscription to the new share issue, and will ultimately determine the final amount used to buy the new shares.

The Treasury insists that announcing the insurance scheme earlier this year helped to restore confidence in the battered banks by convincing investors that the government was standing behind their backlog of bad loans. It says Lloyds should pay for the insurance it has already enjoyed while the details about the scheme are hammered out.

Eric Daniels, Lloyds' chief executive, is telling City investors that he is keen to extricate the bank from the scheme so he can keep the taxpayer's stake below the 50% level and out of the government's control. Under the current terms of the scheme Lloyds would be required to issue "B shares" to the government which do not carry voting rights but would force the taxpayer's economic stake beyond 60%.