The government will drop a pledge to reign in bonuses in return for a series of general commitments from Britain's largest banks to lend more to small businesses.
David Cameron will move away from proposals in the Coalition agreement to take "robust action to tackle unacceptable bonuses in the financial services sector". Instead the Government will unveil a series of commitments from the banks to create a business development fund worth hundreds of billions of pounds, as well as to disclose the compensation levels of the most senior bankers.
The deal, to be announced in the next few weeks, will be embarrassing for Nick Clegg and Vince Cable, both of whom made much political capital out of public anger on bankers' bonuses. Mr Clegg was said yesterday to be still lobbying for a tougher line to rein in "unacceptable" pay.
It also comes against the backdrop of the latest round of bank bonuses which is expected to see Britain's four biggest banks pay well in excess of £5bn to their staff.
On Tuesday, Bob Diamond, the new chief executive of Barclays, will appear before the Treasury Select Committee in what may be a fraught appearance. As arguably the most high-profile investment banker in Britain, he has become something of a lightening rod for the bonus issue.
Yesterday it was claimed that Stephen Hester, the chief executive of the Royal Bank of Scotland, will take home an estimated £2.5m bonus in shares when the remuneration board of the state-controlled bank meets next month. If confirmed, his total package would be worth £6.8m.
But Mr Cameron has concluded that cutting bonuses significantly would simply shut down the London-based investment banking operations of Barclays, RBS and HSBC as their successful staff would move overseas. This would affect not just the success of the UK's banks but also significantly reduce the amount of money coming into the Treasury in tax.
In a signal of the new approach, Mr Cameron said yesterday that while he understood the public's fury over bonuses at a time of spending cuts and the rise in VAT, it was unfair to scapegoat the banks. "Frankly, the whole country has suffered from irresponsible lending practices, irresponsible behaviour," he said. "But we need to recognise that there were a lot of people to blame for the mess we are in and that we shouldn't just think it's an easy scapegoat to pick one in view. Governments made mistakes, regulators made mistakes, politicians made mistakes; everyone was involved."
Mr Cameron said banks needed to be more "socially responsible", but added: "We as a Government and a country have got to get a settlement where we recognise that a successful banking sector is part of a successful market economy."
Last night a source close to the talks between banks and the Government said: "There is a real sense of desire within the banking industry to provide the Government with commitments across a series of areas where they have concerns."
Overall this year the City will see a slight fall in bonuses, but it is unlikely to match the falls in revenue faced by investment banks.
Barclays is expected to pay around £2.5bn globally in bonuses, down only slightly from last year's £2.7bn pay-out, with Royal Bank of Scotland set to spend £1bn, against £1.3bn last year.
Lloyds, without a sizeable investment bank, is likely to repeat last year's £200m payment. HSBC discloses less than the other banks, but it spent £3bn on pay for investment bankers last year, with as much as half made up by bonuses. A similar payout is likely this year. Bankers have also enjoyed rises in basic pay of 20 per cent or more.
Alan Johnson, the shadow Chancellor, said: "This Government came into power with the first paragraph of the coalition agreement saying, 'We will introduce detailed plans to tackle this issue of bankers' bonuses,' when we're going to get nothing. The money being taken off the banks is about £2.6bn through the existing banking levy. That's less than the money coming off of children through Child Benefit [cuts]."
Angela Knight, chief executive of the British Bankers Association, said: "What you have to remember is that the UK has put into place regulations that no other country has done."
Mr Diamond is understood to be preparing to make similar points at the select committee hearing. He will give evidence for its inquiry into competition and choice in Britain's banking market, but Barclays is prepared for another round of sharp exchanges on bonuses. Mr Diamond will seek to head off Barclays' critics by making clear its "deep commitment" to the UK and pledging to lend more to small businesses.
The industry and the Treasury are both hoping that this pledge might help to head off some of the criticism over the bonus issue.
Spending it 'Business is good. Talk is all about bonuses'
"The rich are still rich," smiles the man from Beneteau yachts. The mood at his sales stand near Canary Wharf is buoyant – business is good, and the bankers' bonus season is on its way.
Each February, when City bonuses are paid out, sales of yachts, sports cars, prime real estate, fine wines and other luxury consumer items rocket. This year, new guidelines mean that about half of the value of bonuses will be paid in shares rather than cash, but despite that, the salesmen for prestige goods predict stronger sales than in recent years. The denizens of the City have ridden out the financial crisis, as far as they are concerned.
"We are now nearing a return to pre-crisis turnover in the UK market," says Jean-François Lair, export manager at Beneteau yachts, reflecting the bullish atmosphere at the London International Boat Show in Docklands.
The founder of the yachtmaker Sunseeker International, Robert Braithwaite, chirps: "Bonuses are tied to shares, so they can still serve as guarantees. We are anticipating growth of 3 to 4 per cent, after a few years of holding our turnover at £300 million." In the luxury-car sector, optimism is even higher. Porsche's east London showroom, in the shadow of the Wharf's glass towers, has seen a steady increase in sales since 2009, and its salesmen are preparing for a bumper couple of months.
"Business is good now, there's a lot of talk about bonuses," said one. "The busiest time is March, after the bank bonuses come in in February. Even if people don't have the money up-front under new rules, they'll still be able to finance a car on the back of shares." The nearby Audi showroom reports its best sales in nine years.
Many of those City workers who have seen their bonuses trimmed have been compensated with a much higher basic wage. "Someone on a basic salary of £150,000, with a 100 per cent salary bonus, would now be on £250,000 with a 25 per cent bonus – so the same, more or less," said a fund manager.
Estate agents Savills predict that £1bn of bonus cash will find its way into the residential property market over the next few months, with further "deferred bonus payments" likely to follow. The bulk of the money will be spent in London – with Chelsea, Kensington and Knightsbridge predictably topping the list of popular areas. Two miles down the river, at Newham Borough Council offices, meanwhile, £75m is being slashed from budgets and frontline services are under threat.