The legislation will now go before the upper house, and could come into effect as early as Monday.

The long-awaited legislation to stabilise the financial sector has been the subject of arduous negotiations between the Liberal Democrats and the leading opposition parties.

The Japanese economy, mired deep in recession, has long been burdened by huge bad debts owed to the banks, which have inhibited them from any further lending to companies. The government itself says the debts amount to $650bn (¥87.5 trillion).

Japan has been under intense international pressure to complete its banking reform as soon as possible. Its latest plans are likely to be discussed at the G7 summit in Washington at the weekend.

The IMF earlier this week singled out the Japanese banking problem as among the key issues in the world economy currently as it was stalling an Asian economic recovery.

And the delays have driven the Tokyo Stock Exchange to a 12-year low, dropping below the 13,000 level briefly on Friday. New plan agreed

The ruling party has had to make many concessions to the opposition Democratic party in order to get the legislation through.

The powerful Ministry of Finance is being stripped of its authority to deal with the regulation of the financial sector.

A new body, the Financial Revitalisation Committee, will decide how to deal with failing banks, either temporarily nationalising them, transforming them into a bridge bank, or liquidating them.

Bad banking loans will be put into a special government body, the Resolution Trust Corporation, to be sold off at a discount.

And the failing Long Term Credit Bank (LTCB) will be nationalised and sold off to rival Sumitomo, who has been in merger talks for months.

Bail-outs questioned

But the simmering issue between the opposition and the government over how much public money should be used to rescue failing banks refuses to go away.

The opposition does not want to prop up banks if it means saving the jobs of the executives who caused the crisis.

But the government insists that it has to support the banking sector, in order to prevent an even bigger contraction of credit, and collapse of the economy.

Finance Minister Kiichi Miyazawa said:

"It is fairly apparant that the Japanese economy will face a money shortage if the bad loan disposals proceed rapidly. Public assistance to strengthen banks is necessary at any costs to compensate for a contraction of credit."