The part taxpayer-owned Royal Bank of Scotland has prompted fury by pushing ahead with lucrative staff bonuses despite losing £5 billion last year.
Unions condemned the plans but Downing Street defended the £600 million payments, saying RBS had been "restrained" under the circumstances.
The row came as it emerged the Tory-LibDem Coalition could sell its 80% stake in the bank ahead of the next general election, freeing up billions of pounds.
Critics questioned whether a swift sale would see taxpayers recoup the £46bn pumped into the bank at the height of the 2008 financial crisis.
Meanwhile, the European Union has announced plans to tackle the bonus culture in banks. Under the proposals – which could be in place next year – banks would be barred from paying more than an employee's annual salary in discretionary payments.
David Cameron said he would fight the plans if they threatened the UK's financial services industry, but he risks being outvoted by other EU countries.
Downing Street insists there is no timetable for a sell-off of RBS and the bank's chief executive Stephen Hester admitted the public was still "years" away from getting its money back.
But Mr Hester appeared to suggest RBS could be sold in time for the next Westminster elections in 2015, which political parties have already predicted will be an "austerity" election.
RBS has racked up five years of losses since it was bailed out.
Mr Hester, who waived his own bonus last year, defended the multimillion-pound payouts, which included £215m for investment bankers, saying highly qualified staff were needed to turn the bank around.
In recent months the bank has been caught up in a number of scandals – including attempting to rig interbank lending rates, mis-selling and last year's IT meltdown that left millions of customers without access to their accounts.
Last year's £5bn loss – a sharp increase on the previous year's £1.2bn – includes a £381m settlement for Libor interbank rate fixing, another £1.1bn in provisions to cover mis-selling claims and £175m for the IT fiasco.
The bank increased by £650m the amount put by for the mis-selling of interest rate swaps to small businesses and raised by £450m to £2.2bn its provision for claims related to mis-selling of payment protection insurance.
Chancellor George Osborne said: "I have been very clear I want to see RBS as a British-based bank, focused on serving British businesses and consumers, with a smaller international investment bank to support that activity rather than to rival it. I welcome RBS's announcement to accelerate that strategy."
Chris Leslie, Labour's shadow financial secretary to the Treasury, said: "The timing of the return of RBS to the private sector must be based on the best long-term interests of the taxpayer, not driven by George Osborne's short-term political timetables."
l A woman has denied sending emails to Mr Hester and Sir Bernard Hogan Howe, the Metropolitan Police Commissioner, in breach of a restraining order. Ruby Cooper, of north London, will defend herself against the charges, Snaresbrook Crown Court heard yesterday.
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