The Co-operative Group has said it will buy 632 Lloyds TSB and Cheltenham and Gloucester branches from Lloyds Banking Group, a move it describes as offering "a real challenger bank on the High Street." The deal will give the Co-op 1000 high street branches.
The part-nationalised bank, which is offloading the branches to meet European Union rules on state aid following its government bailout, hopes to complete the sale by the end of November next year.
Senior Policy Advisor at the Forum of Private Business, Alex Jackman, said "If this deal goes ahead it will see Co-op land a 10% slice of the UK’s high street banking pie. That’s a sizeable figure and will give them real clout as a mainstream lender.
“This could be a really significant development for small firms looking to restore traditional relationship banking, where the tick box lending criteria approach will hopefully have no place."
Under the deal, the Co-operative will pay £350 million initially and a further potential £400 million based on performance until 2027 - but the price is far short of the £1.5 billion price tag first mooted.
The Treasury welcomed the announcement, which it said formed part of a raft of measures to reform the banking system and improve competition.
The Co-op said the purchase would triple the size of its banking arm and increase its share of UK branches to around 10%.
The business will bring around 4.8 million customers to the Co-op, meaning the combined business will have a near-7% share of the current account market.
Chancellor George Osborne said: "This is another step towards creating a new banking system for Britain that gives real choice to customers and supports the economy.
"The sale of hundreds of Lloyds branches to the Co-operative creates a new challenger bank and promotes mutuals.
"This follows the sale of Northern Rock to Virgin Money in January and represents another important step towards a more competitive banking sector."
Lloyds said the Treasury was "very supportive" of the deal.
Its announcement comes after lengthy talks and mounting speculation that the deal was on the rocks.
Lloyds chose the Co-op as its preferred bidder in December, but sale plans suffered a series of delays and initial hopes to sign a deal by the end of March were dashed due to protracted talks with regulators.
It is also thought the sale price was hit by the sharp deterioration in the economy, as well as a reduction in mortgage loans to ensure assets and liabilities are more evenly matched.
Peter Marks, group chief executive of the Co-op, said: "This deal would deliver the biggest shake-up in high street banking in a generation.
"Consequently, we believe this would be a great deal for customers, for the public, for UK banking generally and for The Co-operative Group in particular."
He claimed the earn-out element of the deal will see the taxpayer share in the future profits of the enlarged bank.
Lloyds said there would be no changes for the 4.8 million customers affected by the deal until next year.
It will communicate will all Lloyds customers about the changes and clients of the branches being sold will be given the chance to transfer to the Co-op or remain with Lloyds.
Lloyds, which is 40% owned by the taxpayer, said it will provide more clarity on the process once the deal has been formally finalised.