Updated from 5:15 p.m. EST

Citigroup ( C - Get Report) and Morgan Stanley ( MS - Get Report) on Thursday said they would combine brokerage operations in a new joint venture to be called Morgan Stanley Smith Barney.

The announcement culminates three days of speculation about a deal, which creates the world's largest brokerage operation, with 20,000 advisers managing $1.7 trillion in client assets for 6.8 million households. Morgan Stanley will pay $2.7 billion for a 51% stake in the combined business, allowing it better to compete with a newly merged Bank of America ( BAC) and Merrill Lynch.

"This joint venture is an important step forward in our effort to build our wealth management franchise, which we believe will be an increasingly important and profitable part of Morgan Stanley's business in the years ahead," Morgan Stanley Chairman and CEO John Mack said in a statement.

For Citi, the deal provides a much needed cash boost, as it prepares to report what is expected to be a big fourth-quarter loss. Citi said the deal provides a pre-tax gain of approximately $9.5 billion, about $5.8 billion after taxes, and will create approximately $6.5 billion of tangible common equity.

"We will own 49% of this leading wealth management business and will continue to participate in its earnings and growth," Citi CEO Vikram Pandit said in the statement. "In addition, we will generate equity capital that we can deploy to other core businesses which are well positioned to deliver attractive returns in the future. Citi and its clients will maintain access to the industry's leading wealth management platform for capital markets transactions."

The deal is expected to be the first in a series of drastic changes for Citi, in which it is expected to abandon its financial supermarket model. The company, under "extreme" pressure from regulators and facing another quarter of large losses, plans to split certain corporate and investment banking businesses from "worrisome consumer finance operations and other businesses that it no longer considers central," according to the New York Times, citing people close to the situation.

A Citi spokeswoman declined to comment on the speculation.

Citi shares rose 5.4% to $5.90 on Tuesday, after being down nearly 10% at the market open.

The move is evidence Pandit's hands have been tied by the tough banking environment. Pandit had expressed reluctance to part with Smith Barney, but may have no choice but to sell the generally profitable businesses to raise capital.

"While we are not sure that the sale of Citigroup's best assets in the midst of the worst bear market in a generation will unlock the value many break-up proponents hoped for, the realization of a multi-billion dollar gain would clearly support the belief that the sum of Citigroup's parts is worth more than the whole, as currently valued in the market," writes Jeff Harte, an analyst at Sandler O'Neill & Partners.

For Morgan Stanley, the deal is the latest step in its four-month-old odyssey to redefine its business model in the wake of last fall's collapse of the investment banking industry.

Days after Lehman Brothers filed for bankruptcy on Sept. 15, Morgan and rival Goldman Sachs ( GS - Get Report) won approval to convert themselves to bank holding companies. While Morgan mulled a deal with Wachovia before it was acquired by Wells Fargo ( WFC - Get Report) before partnering with Citi, Goldman has appeared far less eager to make acquisitions or radically change its strategy.

Morgan Stanley shares closed with little change at the end of Tuesday.