Leading article: A shameful surrender in the battle of the bonuses

The Government is sounding the retreat in its confrontation over bankers' bonuses.

The Coalition agreement back in May was clear that robust action would be taken over the "unacceptable" rewards for Britain's bailed-out bankers. Yet David Cameron yesterday warned against "banker bashing" and making lenders the "scapegoats" for the recession. Liberal Democrat ministers such as Vince Cable and Nick Clegg, who have been vociferous in criticising bonuses, have gone ominously quiet.

There is also now a talk of a "deal" in which the banks will be permitted to pay out an estimated £7bn in bonuses to staff in return for increasing lending to small businesses. New lending targets would be nothing but a fig leaf. The banks have long claimed to be making these funds available anyway. And they have nothing to do with the issue of remuneration for bankers.

Vast bonuses for staff of our four giant banks – Royal Bank of Scotland, Lloyds, HSBC and Barclays – are both unsafe and unfair. They are unsafe because they can encourage reckless risk-taking by those involved in the investment banking operations of these firms.

The fact that European Union and Financial Services Authority rules mean that a two-thirds portion of bonuses must now be paid in shares and will not be delivered for a number of years is a red herring. Employees of Lehman Brothers were large shareholders in that bank but still ended up driving it to bankruptcy. And even if bonuses are paid in shares, bankers can cash them in eventually. The incentive to load up on irresponsible risks will remain.

Bonuses are also unfair because, as the Bank of England has made clear, these are institutions that enjoy a de facto state subsidy. Since our four largest banks are perceived by investors as being too big to fail, their cost of funding is artificially low. This enhances their profits, and it is these profits that the banks are planning to pay out to staff and management. The Bank of England argues that banks should use any surplus cash they have to replenish their capital, not to reward staff or to distribute to shareholders in dividends.

Yet the Government appears to have decided that it does not want this battle. It does not even want transparency over bonuses. The Chancellor, George Osborne, is resisting a plan to require bankers to reveal how much each bank pays its top staff. The Chancellor seems to have swallowed the bogus argument from the banking lobby that any robust action on bonuses from Britain will have a devastating impact on the international competitiveness of the UK banking sector.

And the banks appear to have managed to convince Mr Osborne and Mr Cameron that their profits this year are a consequence of their brilliant management, rather than the huge quantities of official help they have been given over the past 12 months (from low interest rates, to special lending facilities, to quantitative easing). "A successful banking sector," Mr Cameron argued yesterday, "is part of a successful market economy". In other words we are back to the days of laissez faire for the financial services industry.

If, as seems increasingly likely, the Government waves through large bonuses this year, it will prove a fateful decision. The public sector spending cuts will bite hard over the next 12 months and the cost of living will rise steeply. Meanwhile, unemployment, which is painfully high, could well increase further.

The financial gulf between those privileged few working in the financial sector and the rest of society is on course to widen. The Government's claim that "we are all in it together" is about to be tested, probably to destruction.