If we don't pay big bonuses, our good people are going to walk. That has always been the riposte from investment banks, defending the colossal payouts they give their staff. So Bob Diamond, the American boss of Barclays Capital in London, collects £21 million; the top man at Goldman Sachs here gets £12 million.

While the good times rolled, such rewards raised only a few eyebrows. But not any more - not after banks have lost billions of dollars in the credit crunch.

Many people are blaming a bonus culture that encouraged bankers to take crazy risks for short-term gain rather than long-term investment. That is exactly what UBS, which has written off £19 billion, said in a damning internal report published this week. The Swiss giant confessed some staff were being paid for the amount of gross revenue they generated, rather than actual profit. They received big immediate bonuses and not enough longer-term incentives, such as deferred shares. And some of the methods used to assess the subprime securities they traded were flawed. "No formal account [was] taken of the quality or sustainability of those earnings," said UBS.

Few banks have been willing to make such a public mea culpa. But it is plain that every major financial institution is reviewing the way it rewards staff - not least because of the economic downturn. In a climate of job cuts, everyone expects bonuses to be lower.

A year ago a City banker switching jobs might expect a guaranteed bonus during the first two years; a signing-on bonus; and stock from a new employer in exchange for any share awards they lost by quitting their last job. Now the merry-go-round has stopped and few people are landing such deals, says Helen Haley, who specialises in banking at City recruitment firm Longbridge.

Cynics might add that banks are never shy about looking for an excuse to cut or change the rewards they pay.

So UBS is paying its bankers more stock and less cash. Even for top deal-makers, the cash amount was capped at around $750,000. At Credit Suisse, insiders say they are being offered better pension rights to reward loyalty, in lieu perhaps of cash. And at JPMorgan, which escaped the worst of sub-prime, some bankers are being made to wait longer for their deferred stock to vest - say 18 months, instead of a year, or three years, instead of two.

The idea behind giving deferred stock is that it aligns the interests of the employee with the longer-term interests of the bank and shareholders. Some argue that is exactly the sort of bonus scheme that helps to stop bankers thinking only about short-term gain, but that may be wishful thinking.

Leaving aside the question of whether anyone in the City can forget about making a fast buck, it is not clear owning stock and options makes staff take fewer risks. Look at Bear Stearns, which did more than most banks to reward staff with shares, and still got into trouble.

One former Merrill Lynch banker, who has been involved in its illfated structured credit operation in London, says: "I don't think the flaw was in how you pay your team. You will never get away from short-term incentivisation of the troops. The flaw was in the strategic oversight.

"When Chuck Prince, the former boss of Citigroup, says you have got to keep dancing or you will lose market share, it is a very brave management that says, 'We're going to step back, we won't deliver those returns for the next 18 months'.

"But the executive management at Merrill and Citi was wrong. The bosses didn't have the right tools and data analysis, they didn't have the right risk management people. It's the basics of banking. And they got their job wrong."

So if anyone should forfeit their bonuses, arguably it should be failed bosses such as Stan O'Neal of Merrill Lynch, who walked away with an astonishing $161 million.

An interesting question is whether part of the problem is that banks have become too willing to pay bonuses to everyone. Michelle Bloomfield, director of banking operations at recruitment firm Joslin Rowe, thinks that could change: "A lot of senior managers I talk to are fed up with people just expecting a bonus for turning up. You should be rewarded for being a high performer."

Some banks agree and think the bonus structure should be radically revamped. Says one Swiss banker: "There has been a real mismatch between these products which run for a long time compared to the short-term incentives paid to those who originated them, syndicated them and traded them. What do you do about compensation when the products go wrong?"

Yet few believe big firms are going to reform themselves in a hurry. "If you are Goldman Sachs, why would you change your compensation structure?" asks a rival bank. "You are doing very well at the moment. Why would you submit yourself to an industry-wide voluntary change?" And there is little external political pressure, here or in America.

For now, the argument still holds that the City will pay the going rate to stop good people walking away.

But the most crucial fact about bonus culture is that it is deliberately cloaked in mystery. As one German bank in London puts it: "There isn't a formula where if people make that one risky successful trade, they will make a certain bonus. It depends on personal performance, divisional performance, our bank's overall performance. And a lot depends on the internal politics too. The system is completely opaque."

In banking, more than any industry, it is a sackable offence to discuss one's salary and bonus with colleagues. But it is still the subject everyone gossips about. Because when it comes to bonuses, size will always matter.