Chinese banks will be able to apply to set up wholesale branches in Britain under plans announced by George Osborne.
The Chancellor described the move, agreed with China after two days of talks, as "good for UK jobs and investment".
The Prudential Regulation Authority will enter discussions with Chinese banks in London which will allow them to apply to set up wholesale banks in the UK.
The agreement also contains plans to cement London's position as the global hub for trading in the Chinese currency renminbi (RMB) by giving investors the chance to invest RMB directly into China through London under a pilot scheme.
London will become the first place outside China to be granted an RMB Qualified Foreign Institutional Investor (RQFII) quota, which will initially be set at 80 billion RMB (£8.2 billion).
Mr Osborne said: "A great nation like China should have a great global currency.
"Today we agreed the next big step in making London - already the global centre for finance - a major global centre for trading and now investing the Chinese currency too.
"More trade and more investment, means more business and more jobs for Britain."
The agreement is the result of two days of talks between Mr Osborne and his Chinese counterpart, Vice-Premier Ma Kai, as part of the Economic and Financial Dialogue between Britain and China.
In the joint statement following the meetings, Britain and China said: "Both sides welcomed this as an important step that cements London's major role as one of the most important global centres for RMB trading."
Chinese banks will not be able to open high street branches under the plans but will be able to conduct business with other banks and companies.
RMB is now the ninth most traded currency and London accounts for 62% of trading in it outside China and Hong Kong, according to figures released by the Treasury.
"The People's Currency" was historically pegged against the US dollar but since 2005 China has gradually loosened the peg, allowing it to slowly appreciate.
It has risen 40% over the last seven years, after inflation, but the United States has often pressured China to allow its appreciation to happen more quickly, claiming RMB is undervalued and giving Chinese exporters an unfair advantage.
The Chinese government rejects the claims and is seeking to gradually increase flexibility of the exchange rate with a long-term view to internationalise RMB.
Boris Johnson, who is leading a separate trade mission to China, said the announcement would help London keep its position as the world's financial capital.
The mayor of London said British businesses would now be able to buy products from China in the local currency through London.
Mr Johnson said: "It's one of the things that helps cement our position as the financial capital of the world. The Chinese have decided that London is a great place to locate the trading in renminbi.
"If you're Sainsbury's and want to buy a shedload of fruit juice or underpants from China so you've decided to buy in the local currency, come to London and we'll do the deal for you."