Leading article: A levy that looks like a white flag of surrender

It is unusual for a Chancellor to announce a tax rise outside of a Budget. So what can explain George Osborne's surprise decision yesterday to increase the banking levy he announced last June? The Chancellor says he made the move because he noticed that the large banks were in a better financial condition than expected last year.

That is an insult to the public's intelligence. Nothing about the banks' financial situation has changed in recent weeks. The only new development with regard to the banks is the fact that the Government's behind-the-scenes attempts to reach a deal with the sector over bonuses (known as Project Merlin) have, according to reports, run into trouble.

This move has all the signs of being born of political, not economic, calculation. Mr Osborne knows that an eruption of public outrage is coming in the weeks ahead when the large banks outline the vast bonuses they will pay to their staff for 2010. With this pretty negligible £800m tax rise the Chancellor hopes to deflect some of the anger that will soon be directed towards the Government for its failure to be sufficiently robust with the banks.

It is possible to have a smidgen of sympathy for Mr Osborne. The Coalition inherited the nightmare of bankers' bonuses from Labour. The previous government should have made clear that bonuses were unacceptable when it stepped in to rescue the entire sector in autumn 2008. Yet Labour's missed opportunity does not absolve Mr Osborne and the present Government of its failure to bring the banking sector to heel. The Conservatives took an admirably tough line over bonuses in opposition, demanding that no individual banker should be awarded a cash bonus of more than £2,000. They have had ample time to work out how to implement that policy.

And questions need to be asked about exactly how hard this Government has pushed for reform of banking practices. New research from The Bureau of Investigative Journalism shows that the Conservative Party gets more than half of its funding from employees and firms in the financial services sector. The research also shows that the party's financial reliance on the City has doubled under David Cameron's leadership. How prepared is Mr Cameron to bite the hand that feeds his party? At the weekend, the Prime Minister said he was more interested in maximising tax revenues from the sector than giving the banks a "kick in the pants". Messages are mixed.

The reform agenda for the banks is plain enough. There needs to be an overhaul of remuneration practices at British banks where a small number of traders pocket up to half of the firm's revenues in bonuses, even in the years when the bank itself registers enormous losses. Such a remuneration system means that bankers get a huge share of the financial upside during booms, but none of the downside in busts. It thus incentivises irresponsible risk-taking and a short-term outlook. If other nations are content for their banks' employees to be rewarded in this dangerous manner, that is their lookout. Britain needs to do what is necessary to protect British taxpayers.

There also needs to be a requirement for the banks to lend to small and medium-sized businesses that are presently being starved of working capital. A lack of such lending is undermining economic recovery, according to the Bank of England. Finally, there needs to be a forced break-up of a too-big-to-fail oligopoly that has no incentive to improve the service that ordinary high-street customers receive.

The Government appears to have surrendered on 2010 bonuses. The increase in the banking levy looks depressingly like a white flag. But the most important battle lies ahead. If ministers signal a pre-emptive surrender on breaking up the banks, we will be in no doubt who their real masters are.