The US Treasury agreed overnight to rescue Bank of America with a $138 billion (£93 billion) package of loans, guarantees and new capital only days after the lender officially acquired Merrill Lynch, the Wall Street brokerage.

The bailout of Bank of America is the second-largest rescue mounted by the Treasury since the rescue of Citigroup last year and indicates the continuing struggle faced by American banks in remaining solvent under the weight of their deteriorating mortgage assets.

The Treasury announced early this morning that, with the assistance of the Federal Deposit Insurance Corporation, it would guarantee $118 billion of toxic assets held by Bank of America.

Most of the debts were owned by Merrill Lynch and consist of residential and commercial property loans.

In addition, the Treasury said that it would invest $20 billion in Bank of America from the Troubled Assets Relief Programme (Tarp).

Bank of America has already received $25 billion in funds from the Tarp scheme.

The injection of new capital follows a vote in the US Senate yesterday that approved the release of a second $350 billion round of rescue funds for American banks.

The Treasury's $20 billion investment will carry a heavy cost to the bank, which, in exchange, will issue preferred stock that carries an 8 per cent dividend payable to the Treasury.

Bank of America will also pay a fee in preferred shares to the Treasury in return for the loan guarantees and asset protection.

Although Citigroup has already received funding from the US Government, speculation mounted last night that it could seek a further cash injection as it prepares to announce today what investors expect to be its biggest loss since the credit crunch began.

For the final three months of last year, the bank is forecast to have dropped into the red by more than $10 billion, marking the fifth consecutive quarterly loss.

Citigroup could announce plans for further aid.

It has brought forward its fourth-quarter results by six days and is expected to detail plans to break up its once-giant banking business.

This morning the US Treasury also announced that it would propose rule changes to its Temporary Liquidity Guarantee Program that will extend the length of the government guarantee from three years to ten years.

The maturity extension will apply where bank loans are supported by collateral and where the Treasury's support relates to consumer lending.

The late-night rescue of Bank of America followed a day of tension for the institution during which its shares plunged by 28 per cent.

Citigroup was also pummelled in the bank share rout, with its stock declining 26 per cent.

The two banks are in the eye of the storm that is engulfing America's financial system and the extension of the length of the Treasury's temporary liquidity program is an indication that the US Government sees no market relief on the horizon.

Today Bank of America will announce its fourth quarter and full-year financial results, which some Wall Street analysts believe will show a loss.

In rescuing two huge but damaged institutions, the US Government is attempting to avoid another bank failure similar to that experienced by Lehman Brothers last year, which triggered panic within the financial community.

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