Northern Rock - which expects losses of £1.4bn for 2008 - has been driving away customers to pay off £26.9bn in taxpayer loans racked up following its Bank of England rescue in 2007.

But the firm's move back into the wider market with billions more in taxpayer funds represents the Government's most direct intervention yet to tackle the current drought in mortgage financing.

Mr Hoffman said the Rock's return to "responsible" wider lending would make a "small but important contribution" to the mortgage market.

"Net new lending shrank by around £70bn (in 2008) and Northern Rock was responsible for around half of that fall.

he Rock will now aim to make £5 billion of new mortgage loans this year, and £9 billion next year. Alistair Darling, the Chancellor, said he had ordered to the Rock to change its business strategy because foreign banks have withdrawn from the UK, reducing the total volume of credit available.

The lender was infamous for its Together mortgage product which would lend customers up to 125 per cent of the value of their homes before the credit crunch struck. A restructuring is set to see its poorer-performing loans spun off into a separate legal entity to protect its capital position, shored up with £3bn from the Treasury last year.

The state-owned lender meanwhile sought to defuse a fresh row over controversial bank bonuses after announcing that executives and senior management would receive no cash bonuses for 2008 and 2009 - apart from payouts obliged under contracts. Their salaries will also be frozen.

Mr Osborne also suggested that a Tory government could create new legal curbs to separate investment banks and retail banks. Such rules existed in the US until the 1990s and their abolition has been blamed by some for the recent financial crisis.