Chancellor George Osborne insists he has not given up the fight for smaller City bonuses and warned banks that "nothing is off the table" if they fail to reach an acceptable settlement.
The Treasury is in discussions with the banks aimed at delivering smaller bonuses, greater transparency on pay and "materially and verifiably" increased lending to business, Mr Osborne said.
His comments came just hours after Barclays chief executive Bob Diamond - believed to be in line for an £8 million payout - told MPs that neither the Chancellor nor Prime Minister David Cameron had ever asked him to limit his bonus.
TUC general secretary Brendan Barber denounced Mr Diamond as "the poster boy for everything that is wrong about Britain today" after the Barclays boss told the Commons Treasury Committee that the "period of remorse and apology" from banks needed to end.
The Government is coming under growing pressure as banks prepare to pay out an estimated £7 billion in bonuses, at a time when other sectors of the economy are accepting pay cuts and freezes as part of the drive to pay down the deficit.
Mr Osborne was forced to make a statement in the Commons by his Labour shadow Alan Johnson, who accused him of breaking a promise in the first page of last May's Coalition Agreement to bring forward "robust" legislation to tackle unacceptable bonuses.
Banks were effectively being offered a "tax cut" from the £3.5 billion garnered by last year's one-off bonus tax to the £1.2 billion expected to be raised by the new banking levy, at a time when children were contributing £5 billion and students £2.9 billion towards reducing the deficit, said Mr Johnson.
"Does the Chancellor think that children and students have the broadest shoulders?" he asked. "The Chancellor who said we are all in this together bows down to the rich and powerful whilst bearing down on everyone else."
Mr Osborne told MPs that the Treasury was in discussions with the banks on "a new settlement where the banks pay smaller bonuses than they otherwise would have done; are more transparent about those they do pay; make a greater contribution to local communities and regional economies; treat customers more fairly; and above all lend materially and verifiably more than they were planning to lend to the businesses of Britain, especially the small businesses".
And he added: "If the banks cannot commit to that I've made it very clear to them that nothing is off the table."