Britain’s third-largest banking group joins government scheme to insure toxic assets.

Lloyds Banking Group has become the latest U.K. bank to fall under government control since the run onNorthern Rock in September 2007.

The U.K.’s third-largest bank confirmed Saturday that the government is raising its stake to at least 65%, and possibly as high as 77%, in return for insuring $367 billion dollars in toxic assets. The bank has also promised to increase its lending, primarily to businesses, by $39 billion over the next two years.

The increased stake will come about by the government converting its $5.7 billion of preference shares paying 12% into new ordinary shares.

“Participating in the government’s Asset Protection Scheme substantially reduces the risk profile of the group’s balance sheet,” said Chief Executive Eric Daniels in a statement. “Our significantly enhanced capital position will ensure that the group can weather the severest of economic downturns and emerge strongly when the economy recovers.”

Lloyds will bear up to the first $35 billion of any losses and will pay a fee of $21 billion to $23 billion to the government to participate in the scheme. Discussions to bring Lloyds into the arrangement have been under way for several days.

The bank says the toxic assets covered by the governments insurance are expected to include residential mortgages ($105 billion), unsecured personal loans ($26 billion), corporate and commercial loans, including commercial real estate and leveraged finance loans ($214 billion) and treasury assets, including the group’s Alt-A portfolio ($24 billion).

Eighty percent of the assets come from HBOS, which Lloyds agreed to buy in a government-brokered deal in September 2008. HBOS reported $14 billion of loan losses last year, up fivefold from 2007 .

Lloyds’ share price fell 31% in London trading in the past week on rising concerns about the bank’s ability to absorb the losses at HBOS.

The government’s objective in insuring bank assets is to promote lending by taking on some of the risk. Although last year’s round of capital injections did stem some of the sector’s share-price collapse and did build up banks’ capital reserves to better levels than before, lenders were under little pressure to actually spend the cash and grease the wheels of the rickety economy.

Royal Bank of Scotland , which is 70% government-owned, agreed in principle Feb. 26 to an asset-insurance deal that could see the state increase its stake to 95%.