Gordon Brown promised a “transformation” of the way the financial sector is policed as the centrepiece of Wednesday's Queen's Speech.
A Financial Services Bill will offer tough new powers to City regulators to tear up bankers' contracts if they include excessive pay and bonus deals which might threaten the stability of the financial system.
In an upbeat podcast on the Downing Street website, Mr Brown said Britain had a “bright future” ahead of it after the economic difficulties of the past year.
He said the UK had fared well in terms of jobs and repossessions compared with the last recession under the Conservatives in the early 1990s.
And in sharp contrast to the vision of belt-tightening on offer from the Tories, the Prime Minister said he was “optimistic” about the coming period “which I believe can be one not of austerity but progress”.
Chancellor Alistair Darling said the Financial Services Authority would be given new powers to stop bankers pocketing excessive bonuses or to cancel pay packages which rewarded undue risk-taking.
Legislation to be unveiled on Wednesday will also enable the FSA to require banks to renegotiate remuneration packages which breach its pay code, and fine those which continue to offer unjustifiable sums.
Mr Brown said: “We will ensure that the banking crisis we have experienced over the last two years should never again come at a cost to the taxpayer.
“This means a transformation of the way the financial sector is policed, with banks themselves and not the taxpayer made to pay for bank failings.”
Mr Darling said that bankers must start seeing themselves as “fellow citizens” and said some of the bonuses they had received were viewed by the public as “ludicrous”.
The Chancellor said his bill would give the FSA “powers if necessary to tear up contracts that would result in payments being made that would cause instability”.
The new rules will come into effect next year if the Bill completes its passage through Parliament before the election — which must be held by June 3 — and will affect all new contracts. They will apply to all UK banks, including RBS, Lloyds, Barclays and HSBC as well as the UK operations of global investment banks like Goldman Sachs.
Other provisions will require banks to hold larger capital reserves and to prepare so-called “living wills” to ensure they can be wound up in the case of failure without putting the entire financial system at risk.
Mr Darling dismissed suggestions that the Bill amounted to an incomes policy for banks which would drive financial services companies abroad.
“Our starting point is we want London to remain as the world's foremost financial centre,” he said. “We want this to be a good environment where firms from all over the world come and do business.
“But part of that is to make sure that there is a tough supervisory and regulatory regime.”
He said he had no objection to people being “rewarded for a hard day's work”, but said it was wrong that bankers should be “rewarded to do things which ultimately brought the banking system crashing down”.
The bill will also bar financial institutions from encouraging customers to borrow more than they can afford by sending out unrequested credit card cheques.
And it will allow bank customers to join forces in US-style class actions to demand compensation for “rip-off” bank charges.