A HUGE overhaul of the "unacceptable" bonus culture in the City was launched today by its chief watchdog.

In a clear threat to banks and traders, the Financial Services Authority promised "immediate action" if their bonus policies were not reformed.

In a strongly worded five-page letter to City bank heads the FSA's chief executive Hector Sants said there was "widespread concern" that excessive bonuses had "contributed to the present market crisis".

Although bonuses are expected to be well down on recent years, around £3.5billion is still likely to be paid out at the year end.

The FSA letter said that remuneration policies for traders and bankers "frequently gave incentives to staff to pursue risky policies ... to the detriment of shareholders and other stakeholders, including depositors, creditors and ultimately taxpayers".

Although the FSA said it did not want to get directly involved in setting levels of bonuses at banks it will now place them under intense scrutiny.

FSA officials will carry out a programme of visits to banks to make sure "bad practices" have been eliminated. It also plans to publish its findings about the City's bonus culture next year. The letter outlines unacceptable bad practices that it wants to stamp out.

They include:

● Linking bonus to just one year's performance rather than average performance over a number of years.

● Calculating bonus only on the basis of financial performance. The FSA wants the bonus to be linked to other skills such as "risk management".

● Remuneration where year-end bonus makes up almost all the payment. The FSA is looking for all compensation packages to include a much larger fixed element so that staff do not become completely fixated by their bonus.

● Bonus paid wholly in cash. The FSA wants a higher proportion of bonus to be made up of shares or share options.

● All bonuses paid up front. The FSA has asked that "a major proportion" of a bonus is deferred and paid over several years.

● No high level oversight of remuneration to senior executives and staff. The FSA says banks should set up a board level committee to set bonus policies and oversee "individual remuneration awards over a certain threshold".

● Traders able to assess the value of their own positions, giving them too much influence over the value of bonuses. The FSA says there should be more independent assessment.

The overhaul does not apply to bank board directors but to the tens of thousands of workers in the City who are rewarded with a year-end payment.

Gordon Brown has already made clear his personal "anger" at huge rewards for "irresponsible" risk taking and has warned that those found guilty will be punished. Over the past decade some £50 billion has been paid out in bonuses to City workers, helping to fuel the capital's long housing boom.

The review will throw open to scrutiny for the first time an area of the City uniquely shrouded in secrecy and mystery.

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