Royal Bank of Scotland's hopes of paying bonuses twice the size of salaries have been scuppered by the Government.
Under new European rules, the part-nationalised bank requires the approval of shareholders to award variable remuneration up to 200% of fixed pay.
However, RBS has been told by UKFI, which manages the Treasury stake, that it will not support a resolution which proposes a 2:1 ratio. It means the proposal will no longer be put to shareholders at its AGM in June.
With other banks currently seeking approval for the 2:1 ratio, the bank warned it now faces a "commercial and prudential risk" as it tries to operate within a 1:1 fixed to variable pay ratio.
It said: "The board believes the best commercial solution for RBS is to have the flexibility on variable to fixed pay ratios that is now emerging as the sector norm.
"This would also allow RBS to maintain the maximum amount of compensation that could be subject to performance conditions including clawback for conduct issues that may emerge in future. This position was understood during consultation with institutional shareholders."
A Treasury spokesman said there could be no rise in the bonus cap because the bank has not yet completed its restructuring and remains majority public-owned.
The Treasury will not oppose a 2:1 bonus ratio at Lloyds Banking Group, in which it still has a 25% stake, because the bank has largely completed its restructuring.
It added that RBS's pay policies mean that the firm will remain a back-marker in its overall remuneration compared with other banks.
The spokesman added: "We have made clear there will be no rise in the bonus cap for an RBS still in recovery, but a bonus cap at Lloyds that reflects the progress it has made in getting money back for taxpayers.
"A few years ago, bonuses were out of control, banks needed bailing out and the economy was shrinking. Under this Government's long-term economic plan bonuses are down, the banks are recovering and the economy is growing."
The EU bonus rules, which came into force on January 1, limit annual payouts for 2014 onwards to 100% of annual salary, or a maximum of 200% with shareholder approval.
The Government believes the policies will not support stronger and safer banks and has launched a challenge to the rules in the European Court.
Barclays yesterday won the support of shareholders for payments of up to 200% of salary, while also introducing new role-based pay awards that mean staff can still pick up bumper handouts.
RBS, which is 81%-owned by the taxpayer, said chief executive Ross McEwan will receive a salary of £1 million this year, as well as the potential for up to three times that amount through the company's long-term incentive plan.
The bank will follow the lead of other banks in paying a fixed allowance to senior staff in addition to salaries in a move seen as side-stepping the EU bonus cap.
It means Mr McEwan will be entitled to an additional payment of £1 million from next year, although the bank added that the chief executive and other board members will no longer be entitled to receive annual bonuses.
The bank said its new pay policies cut the maximum potential award to directors by 16%, as well as maintaining its exposure to shares and clawback procedures.
Shadow Treasury minister Cathy Jamieson said: "George Osborne is in a terrible muddle over bankers' bonuses. He is spending taxpayers' money on a legal fight in Brussels against the bonus cap and yet imposing the minimum cap at RBS.
"The Government has bowed to pressure on RBS and finally admitted that bonuses of two times salary would be unacceptable at what remains a bank in Government ownership. They voted against Labour's motion to impose the minimum cap at RBS in January, but have now been forced to reverse their position.
"But, confusingly, at the same time the Chancellor is supporting higher bonuses in Lloyds Bank and elsewhere.
"People who are facing a cost-of-living crisis are rightly angry about excessive rewards for failure in banking over recent years. The Chancellor should accept the logic of today's announcement and drop his legal action to block the bonus cap.
"And he should heed Labour calls to implement existing legislation on transparency in pay at the top and repeat the tax on bankers' bonuses to pay for a compulsory jobs guarantee for young people out of work for a year or more."