Despite losing billions in 2011, bailed-out British banks, including Lloyds and RBS, continued to pay out millions in bonuses to its top executives. The government has also thus far refused to step in, while public pressure mounts on the executives and politicians. Why are big bonuses still a prevalent part of banking culture and is there really nothing we can do?

When Royal Bank of Scotland (RBS) boss Stephen Hester waived his £963,000 bonus in January this year, he wrote a candid letter to his staff revealing the motive behind his decision. Hester confessed to workers at the largely state-owned bank that press coverage "had been discomforting to say the least".

Hester's surprising admission proved that even bankers are not immune to the psychological pressures of a guilty conscience. The newspaper articles had expressed outrage that a bank, which was bailed out with £45 billion of public money, had paid £785 million in bonuses for 2011 despite losses of £2 billion.

Although Hester waived his bonus under duress, other senior executives at RBS received their million-pound bonuses and the company's 17,000 investment bankers amassed a total of £390 million.

Related: Banker Bonus Scene Clarifies in EU, Still Confused in US, UK

Related: Big Banks' HUGE Bonuses Draw Federal Ire - But No Action

Related: Wall Street Bonuses To Fall By 20-30%

Meanwhile, Prime Minister David Cameron refused to impose legislative solutions to restrict bonuses at the state-owned bank. He simply urged RBS politely to show "restraint" in its awards for senior executives.

"We are not going to micro-manage bonuses... The banks are doing a good job and making good progress," was the official Downing Street line.

Professor Stefano Harney, an expert on business ethics at Queen Mary University London, though is one prominent voice who believes the Government should step in to limit executive compensation.

"We need permanent change to proactively tackle the issue," he said. "Laws must be in place well before we are in the absurd position of a publicly owned bank's management having the Government over a barrel."

The UK Government has done nothing yet, but claims it intends to legislate to give shareholders a binding vote on executive pay. At present, shareholders have a non-binding, or advisory, vote on pay. Measures under consideration include shareholders getting a veto both on pay packages and on deals given to executives who leave jobs in which they have failed. An announcement could be made in the Queen's Speech in spring.

Opinions however differ about the effect the proposals would have on the pay structures and bonus packages of Britain's top executives, which have risen by an average of 4,000 percent in the last 30 years according to the High Pay Commission.

Under the present rules, Professor Cary Cooper, a distinguished Professor at Lancaster University Management School, says there was nothing the Government could do to prevent RBS handing out massive bonuses despite its losses.

"The Government missed the opportunity when they bailed out RBS and Lloyd's in 2008 to put clauses in the contracts saying there could be no bonuses for anyone until the public-owned banks were back in profit.

"The rule ought to be that until the entire bank is profitable, no individual should get a bonus. Some of them were working at RBS when it went bust, so they can partly be held responsible. In hindsight, the Government was in a rush and panicking a bit."

Cooper dismissed the banks' argument that high bonuses are necessary to attract and retain the best talent as a myth. "It's the classic blackmail argument used by bankers. But the answer is - 'well, you are not making profit, so we can't afford it until you work more efficiently'.

"If they want to go for bigger bucks elsewhere, let them go. It's a young man's game and there's new talent coming through in the banking world all the time. If they are totally money-driven, that's the kind of greedy attitude that got us into this mess in the first place. The bottom line is they will sell any product no matter how risky to get money."

Related: Moody's Slams Insane Bank Bonuses

Related: "We The 99%": UK Investors May Get To Vote On Executive Pay

The story at Lloyds, the other bailed-out British bank, is more complex, and demonstrates the difficulties of imposing controls on the banks.

Unlike RBS, Lloyds fell foul of new regulations, introduced by the Financial Services Authority after the 2008 crisis, which said that bankers should have to give back part of their bonuses if their bank performed worse than expected. Lloyds, which owns Halifax and Bank Of Scotland, made a £3.2 billion loss after mis-selling PPI credit insurance and was forced to make a retrospective reduction in the size of its 2010 bonus packages.

A total of £2 million was cut from executive compensation. Former chief executive Eric Daniels had to surrender £570,000 of his £1.45 million bonus and other directors and executives gave up between £100,000 and £250,000 each. RBS also mis-sold PPI insurance, but it was not required to claw back bonuses from executives under the new rules because it stopped selling its main PPI product at the end of 2008.

The bonus reductions still left Lloyds' bankers with huge awards, which totalled £375 million for 2011 and critics argued that £2 million was a paltry sum compared to Lloyds' huge losses of £3.5 billion for 2011. Also, because the clawbacks are at an executive level, their influence over the majority of bankers will be limited.

Neither is the FSA judgement on the Lloyds' executives particularly damning to the reputations of the executives. The FSA said withdrawing bonuses did not amount to an admission of guilt over PPI mis-selling, so the bankers would not be disqualified from jobs in banking. Lloyds admitted only that its executives were "accountable", but said they were not "culpable".

The City of Greed

So far, we have discussed whether bonuses can be reduced, or clawed back. But many writers and academics have gone further still and questioned the dogmatic belief that bonuses are a sound means of motivating good behaviour.

A powerful critique of "The City's" bonus culture has come from Geraint Anderson, a former stockbrokers and hedge fund manager who writes the cult 'insider' column Cityboy and unmasked himself as a whistleblower in his 2009 book Cityboy: Beer And Loathing In The Square Mile.

Anderson said: "Bonuses were a major cause of the short-term reckless gambling that led to the financial crisis. The creation of trillion of dollars of toxic loans primed to explode was not just about bankers being reckless, or stupid. The people who invented them and traded them knew the whole house of cards would fall down at some point. But they also knew they could rake in huge bonuses, which would not be taken back if it was later shown that these supposedly profitable new products were, in reality, disasters waiting to happen."

Related: Bankers in London Need Mental Help

Related: How Can Virgin Money Shake Up the UK's Banking Sector?

From the day Anderson joined "The City" in 1996, it was drummed into him that he had to make as much money as he could, and fast.

"From the word go, I was constantly told by my seniors that the party would end at some point and the building would be a car park in 10 years, so make hay while the sun shines. This pressure causes the mentality of doing whatever you have to do to make money in the short-term. If that means semi-criminal acts, or recklessness, or creating financial products that are doomed to explode in a decade, then that's fine."

"That's the reason we've seen insider trading, the spreading of false rumours, and the manipulation of markets. You do whatever is necessary now because most people know the City is a young man's game."

Anderson said the financial crisis was a rational, logical outcome of the bonus culture.

"The City is full of very clever, ruthless, greedy people who manipulated the bonus system to line their own pockets. They do not think - funnily enough - about serving society's needs, but their selfish requirements," he said.

According to Anderson, he was always an outsider to "The City" culture. Despite his private school and Oxbridge education - which is typical of the white middle-class and upper middle-class "Cityboys" - his father was the Labour peer Lord Anderson of Swansea, and his devoutly religious mother Dorothy was the daughter of Bolivian missionaries.

Anderson fell into a job in the City when his brother Hugh, a banker, organised an interview for him. But he soon got sucked into the avaricious mindset.

"I started as a nice, left-wing hippy type but I became a City boy. If you are always dealing with money and trading money and talking about money it becomes the be all and end all of your existence and the bonus becomes a gauge for how wonderful a human being you are," he said.

"You believe that the efficient free market correctly evaluates your worth, so if your bonus is half that of Norbert on the next desk it means he is twice as valuable as you are. I became like that and my parents used to tell me at the dinner table to stop talking about money."

Individuals, like Anderson, who would behave morally and responsibly in other walks of life, end up playing the game and manipulating the system to earn larger bonuses.

"For example, you can increase your bonus if you are good at office politics, which is a huge preoccupation for most City boys. This means stabbing people in the back to steal their thunder. The City is worse than anywhere else in the world for that, apart from possibly politics. If you stab the right person and steal the right thunder you can add £50,000 to your bonus."

"Bankers will also fabricate profits to boost their bonus. They use creative accounting. For example, they could argue that a CDO will produce lots of profit in the future, but it hasn't crystallised yet. They look forward and discount back future profits. Then they say 'look, I've made you X amount'. Later, you find out that instead of earning the bank £10 million, they have lost £10 million, but they already have their bonus money. It's semi-criminal mathematical trickery."

Do Bigger Bonuses Really Boost Performance?

Academic research also lends support to Anderson's 'insider' debunking of the confident assertion that large bonuses improve performance.

In one famous experiment, Professor Dan Ariely of Duke University, North Carolina, asked Indian villagers to do creativity, memory and motor skill tests. Different groups were offered four, 40 or 400 rupees for achieving high scores. Instead of improving performance, the higher rewards had an adverse effect. Those offered 400 rupees - the equivalent of five months' local average spending - earned just 20 per cent of the maximum possible compared with 36 per cent for those offered lower sums.

Professor Ariely then conducted a second experiment on 24 US students who received cash rewards if they performed well in maths and repetitive key-pressing tasks. Some were offered from US$15 to US$30, others from US$150 to US$300. For the easy key-pressing tasks, the higher rewards led to a better performance, but in the much harder maths tasks, they had the opposite effect.

Professor Ariely concluded that bigger bonuses could boost performance for simple manual labour, but not for more mentally challenging work, such as working on complicated financial products in the City, or on Wall Street.

The banking industry in America also conducted similar experiments, which confirm Professor Ariely's findings. In 2005, the Federal Reserve Bank of Boston published research called Large Stakes and Big Mistakes. Behavioural economists offered students bonuses for good performance in tapping a keyboard as fast as they could, and then doing more complex maths.

Again, the bonuses worked well for the simple task, but worsened performance on the harder task.

"Tasks that involve only effort are likely to benefit from increased incentives," wrote the economists. "While for tasks that include a cognitive component, there seems to be a level of incentive beyond which further increases can have detrimental effects on performance."

Related: UK's Alarming Apathy Towards Its Banking Sector's Criminality

Related: The Grand Charade Of UK's Most Dangerous Banker

The argument that financial incentives are needed to incentivise top bankers not to seek employment elsewhere, also turns out to be questionable.

Harvard academic Boris Groysberg studied 366 Wall Street equity analysts who changed employers between 1988 and 1996 for his bookChasing Stars. All 366 had been rated number one at their old bank, but once they moved on their performance levels plummeted for at least five years.

Groysberg concluded that the focus on individual bankers' expertise was out of proportion to their skill levels. Success, it turns out, was more dependent on the efficiency of a network of employees, rather than that of a single individual.

David Smith writes for EconomyWatch.com which originally published this article.