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LONDON, Feb 2 (Reuters) - Britain this week pressured one banker to give up his bonus and humiliated another by stripping him of his knighthood, populist moves that may assuage taxpayer anger over propping up failed banks, but risk long-term damage to the City financial district.
Britons, facing bleak job prospects, rising prices and harsh state spending cuts, are incensed at huge executive pay packages, in particular bonus payouts to bankers many blame for triggering Britain's worst recession since World War Two.
Billions of pounds in bonuses are expected to be lavished on bankers this year on top of hefty salaries, underlining a widening gap between rich and poor in a country where many identified rising inequality as one factor behind riots that ravaged the capital and other British cities last year.
Scrambling for a response to the public mood, the government urged pay restraint at the Royal Bank of Scotland, almost completely state owned after being rescued by the taxpayer, while a committee of civil servants cancelled the knighthood of the bank's former chief executive.
Critics say the one-off moves are no substitute for systemic change when tackling excessive corporate pay, and create fears of a witch hunt among bankers and other business professionals operating in Britain's finance-driven economy.
The Conservative-led coalition wants to rebalance the economy but financial services still account for more than 10 percent of output. Prime Minister David Cameron has gone out on a limb to protect the industry from what he regards as punitive European Union curbs.
The pay row threatens to escalate over this year's bonus season as more bumper payouts are awarded, including to American Bob Diamond, head of Barclays, who caused waves last year by saying the time for banker remorse was over.
Diamond was awarded a 6.5 million pound bonus in 2011. The average British household income is 26,000 pounds after tax.
A parliamentary vote next week on banker bonuses, brought by Britain's opposition Labour party, will throw fuel on the fire and make the government's dilemma more acute: back banks and risk public ire, or bash banks and risk damaging business.
"What concerns me is that the government appears to be going after individuals without first of all establishing the principles upon which people are going to be judged," former finance minister Alistair Darling told the BBC on Wednesday.
"We are getting into awful trouble here if we go after people on a whim and we don't have a clear set of principles against which we can judge people," he added.
Adding to the sense of confusion is the Conservative-led government's apparent U-turns on two key messages on executive pay: that failure should not be rewarded -- and by extension success should -- and shareholders should take greater action in blocking excessive remuneration.
The Conservatives are traditionally the party of big business, while their smaller Liberal Democrat coalition partner has long been critical of banking excesses.
However, all three main parties have ramped up the rhetoric in recent weeks, trying to redefine a kinder form of capitalism to mollify a hostile public reaction.
Under huge pressure, RBS' current boss Stephen Hester on Sunday waived his bonus, worth almost a million pounds, a move welcomed by the government even though it had earlier praised him for making progress in turning the stricken bank around.
Hester was recruited to fix problems at RBS after the bank hit trouble, and had nothing to do with a disastrous decision by former boss Fred Goodwin, who on Tuesday lost his knighthood, to buy a Dutch bank just as the global credit-crisis struck.
Goodwin, dubbed "Fred the Shred" by the media for extracting savings from deals by axing staff, gained his knighthood -- an honour bestowed by Britain's queen and which gives the holder the right to use the title "Sir" -- for services to banking.
Now he joins a group that includes Zimbabwean President Robert Mugabe and Romanian dictator Nicolae Ceausescu of people who have subsequently had that prized honour annulled.
Other finance industry figures have escaped censure despite heavy criticism of their leadership in the credit crisis.
"Scrutiny without fairness, judgment without balance and action without thought for the unintended consequences must be avoided. Today, especially on the emotive issue of pay, we are at risk of doing just that," wrote Confederation of British Industry chief Roger Carr in Tuesday's Times newsapaper.
The government may have also undermined its drive to urge shareholders to clamp down on bonuses, which Prime Minister Cameron last month said was "out of control".
Last week, Business Secretary Vince Cable announced government plans to give shareholders more powers to block pay proposals and claw back cash from highly-paid staff who fail to deliver.
Britain owns 83 percent of RBS after taxpayers poured 45 billion pounds into the bank to rescue it from insolvency, yet the government was hesitant to interfere in RBS bonuses, saying that the bank was run "at arm's length" from the state.
"The government should be making the most of the shareholder action proposal and putting it into practice. Is it doing that? No, absolutely not," said Spyro van Leemnen, supporter of the global Occupy movement against corporate greed, in which campaigners have pitched tents in London's financial district.
Their chosen site, outside London's iconic St Paul's Cathedral, has dragged the Church of England into the increasingly fraught debate on inequality, which last year prompted resignation of two of the cathedral's top clerics.
The row battered share prices for RBS and Lloyds, another bank in which taxpayers hold a large stake, with falls in the company's valuation on Monday far outweighing taxpayer gains from Hester turning down his million pound bonus.
Commentators ascribed the fall to fears that bonus restrictions could damage performance.
Some say bonuses are needed to reward achievement and attract talent in a global job market. Critics say bonuses appear to be paid regardless of performance and encourage the kind of short-term risky deals that led to the credit crisis.
"This week we have seen what some have termed 'anti-business hysteria' but the British public is savvy and recognises that business is a force for good," said British Chambers of Commerce chief John Longworth, who worried that the bonus row was distracting the government from reviving a shrinking economy.
Both left and right-wing British newspapers on Thursday carried opinion pieces and letters condemning the handling of the bonus issue.
For some, the government had caved in to mob rule and targeted two individuals unfairly. For others, the bankers' censure was symbolic and did not go far enough.
The only certainty appears to be the issue's continued use as a political football.
Centre-left Labour, in power when RBS was rescued, has been among the most strident in calling for controls on excessive pay, in particular at RBS. On Thursday it condemned the government's handling of RBS bonuses.
"It has been disorderly, chaotic and slipshod and it sends a terrible signal around the world about the way government deals with business," Labour finance spokesman Ed Balls said in Thursday's Financial Times newspaper.