Police have averted a potentially explosive situation after overpowering a man who allegedly threatened to set a car alight outside the NSW Parliament.

The man at the centre of a two-hour siege was known to police and was a regular visitor, it's been confirmed.

The stand-off began shortly before midday (AEDT) on Friday when guards at the main entrance of parliament, on Macquarie Street in Sydney's CBD, noticed a man in a white sedan acting suspiciously.

For over two hours the man, a 58-year-old from the Wollongong area, passed lists of demands from inside the car to plain-clothes police negotiators.

Hundreds of city workers gathered at the police cordon as Macquarie Street and Martin Place was blocked off and parliament went into partial lockdown, before the siege ended dramatically just before 2pm.

There were loud bangs and flashes as up to a dozen heavily armed tactical officers swarmed the vehicle, firing a canister of gas inside and smashing the car's windows before dragging the man into custody.

Police officers and firefighters could be seen removing a device from the car before conducting tests on the vehicle.

NSW Police Assistant Commissioner Mark Murdoch told reporters the man had a container of flammable liquid, which AAP understands was believed to be petrol, which he was threatening to set alight.

Mr Murdoch praised the quick actions of police.

"When that man attempted to light a cigarette lighter, wind the windows of the car up with what we believe to be a container of flammable liquid in the vehicle, those officers put their lives on the line this afternoon and they resolved the situation in a peaceful manner,'' he said.

The man was receiving medical attention for minor cuts suffered in the struggle with police, Mr Murdoch said, but compared to the threats he was making those injuries were "very, very minor in the scheme of things''.

He said a major incident at lunchtime in the centre of the CBD was of obvious concern.

"The mere fact we're in front of our state parliament, in the middle of Sydney in the middle of the day - certainly that posed a risk,'' Mr Murdoch said.

''(But) at no time was any member of the community at risk, no one in any building was at risk and importantly no members of parliament were at risk because of this incident.

"We were very comfortable at all times that we had the measure of the fellow.''

Mr Murdoch could not confirm reports the man had sought a meeting with Premier Barry O'Farrell, who stayed inside parliament throughout.

But he did confirm the man was a "regular visitor'' to the parliamentary precinct.

"He was making certain demands of the police but we weren't in a position to meet those demands, nor were we ever in a position to entertain them,'' he said.

"Our whole tactic was to contain and negotiate with the man.

Macquarie Street has now been reopened to traffic.