President Barack Obama today declared his intent to take on Wall Street by announcing plans for stringent rules on the banking sector that prompted comparisons with the draconian regulations introduced after the Great Depression.

In the boldest move taken by any government around the world to respond to the financial crisis, Obama told banks they would no longer be able to take risky bets with their own capital to make money on the financial markets.

Banks which take deposits will not be allowed to use their own money to take bets on markets, run hedge funds or make private equity investments through what he called the "Volcker rule" after former Federal Reserve chairman Paul Volcker.

He also wants to prevent further consolidation of the financial system in the US and will ban takeovers and mergers among American firms in the sector.

Obama said the new proposals would keep taxpayers from being "held hostage" by banks that have become "too big to fail" and that pose a risk to the entire financial system.

Wall Street was nervous ahead of the announcement, with the Dow Jones Industrial Average down more than 160 points before he spoke and then falling a further 40 points once he had finished. The FTSE 100 index in London fell sharply in afternoon trading as the markets feared the impact on UK banks such as Barclays and RBS.

"We simply cannot return to business as usual," said Obama.

His words were immediately interpreted as a Glass-Steagall Act for the 21st century, in reference to the legislation introduced in 1933 that prevented commercial banks which took deposits from customers from carrying on investment banking activities.

Fresh from the historic loss of a Democratic senate seat in the Kennedy-stalwart state of Massachusetts this week, Obama's assault on Wall Street followed the release of near-record profits from Goldman Sachs and bonus average pay for its 32,000 staff of $500,000.

Obama made it clear that he was appealing to the electorate. "Over the past two years more than 7m Americans have lost their jobs; rarely does a day go by that I haven't heard from folks who are hurting," he said.

"Even as we dig our way out this deep hole it is important we do not lose sight of what got us in this hole in the first place," Obama said, referring to the taxpayer bailout of Wall Street in October 2008. "While the financial system is far stronger today than it was one year ago, it is still operating under the exact same rules that led to its near collapse."

Goldman, the most closely watched bank on Wall Street, insisted it was showing "restraint" in its bonus payouts by demanding its 400 partners donate a combined $500m to its charity, Goldman Sachs Gives, and reducing the proportion of revenue allocated to pay from 48% in 2008 to 35.8% in 2009 – the lowest on record.

The 141-year-old New York-based bank has been pilloried as the exemplar of banking pay excess. Its London-based employees will be subjected to the chancellor's 50% special tax on bonuses of more than £25,000 and expects to a receive a contribute "hundreds of thousands of dollars" to the UK exchequer. Goldman has pushed back against criticism although its chief executive Lloyd Blankfein was recently lambasted for claaimed that his employees were doing "God's work".

Lord Oakeshott, the Liberal Democrats' Treasury spokesman said: "It's restraint, but to everyone else it's gross greed. they are on a different planet."

Shares in Goldman were hit hard by Obama's announcement, falling 5%.

Obama has already tried to show Main Street that he is trying to restrain Wall Street through the "financial crisis responsibility fee" he announced last week to bring in $90bn over 10 years into the US coffers.

An EU proposal to tax banks in Europe also gained ground yesterday when a Swedish proposal to introduce a levy on profits was backed by Spanish finance minister Elena Salgado, whose country currently holds the EU presidency.

Salgado said the tax, which will be set aside in a stability fund, will be examined at an informal gathering of European finance ministers in Madrid.

The meeting in April could endorse the tax, which Sweden believes could raise £7bn, before going forward to the Commission.