Clegg and Bank crank up the pressure over City bonuses

As bonus season approaches, the Government and the Bank of England have both been on the banks' case this morning - albeit from different angles. The Bank's argument is largely financial: in its latest Financial Stability Report, it says that UK banks are by no means insulated from the sovereign debt crisis in the Eurozone, and so would be well-served to hang onto as much capital as possible. Whereas the Government is taking a more moral stance: in today's FT, Nick Clegg insists the Coalition will not ‘stand idly by’ if the banks fail to show 'visible restraint'. But will the pincer movement work?

The good news, according to the Bank's latest FSR, is that our banks are in a much healthier state than they were a year ago in terms of profitability, capital cushions and so on  - and whatever you think of bankers, that has to be a good thing for the economy. But the Bank is clearly worried that contagion from the Eurozone crisis could still cause the UK serious trouble, given how interconnected the European financial system is. In other words, since our banks have hundreds of billions of pounds of loans sitting in France, Germany and others, we can hardly sit back smugly and pretend it's someone else's problem.

As a result, the Bank suggests, banks should try and strengthen their position by building up bigger capital buffers - and the best way of doing that is to hang onto earnings, rather than dishing them out in bonuses and dividends to their staff. This would be in their 'collective interest', it suggested, and it would allow them to keep lending in a way that facilitated the recovery.

This chimes nicely with the politicians' own wish to clamp down on excessive bonuses this year, if only because they know how angry the voting public will be if they don't. Nick Clegg was ramping up the rhetoric again in today's FT: the banks, he said, do not operate ‘in a social vacuum' and it was 'wholly untenable to have millions of people making sacrifices in their living standards, only to see the banks getting away scot free.' He suggested the Government was ready to step in, if that was what it took to produce a 'cathartic settlement' - though he was a little sketchy on what that would actually involve, in practice.

And there's the rub. Will all these fine words, or the Bank's sensible financial logic, be enough to persuade banks to change the habit of a lifetime and show some genuine restraint at bonus time (other than a bit of fiddling around the edges)? Sceptics will worry that unless the rules change across the board, individual banks will be too worried about giving up competitive advantage. While hammering them too hard may result in the likes of HSBC deciding they're better off shifting their HQ to Hong Kong instead. So the likeliest outcome remains some kind of fudge – which won't really satisfy anyone.