Addressing an audience at Reuters, in Canary Wharf, Mr Osborne said: "I am today calling on the Treasury and the FSA [Financial Services Authority] to combine forces and stop retail banks - in other words the banks that lend directly to businesses and families - paying out profits in significant cash bonuses. Full stop."
He said: "It was a year ago that I first warned that the money taxpayers provided to support bank lending must not be diverted into bonuses. A year later, the banks are making billions in subsidised profits.
"But instead of using these profits to lend more and get credit flowing again, the banks are threatening to pay out billions in cash bonuses instead. If this happens it will make the credit crunch worse."
He added: "We need to take emergency steps to support bank lending and move the economy forward this winter. The banks have to understand that we are all in this together."
Mr Osborne also said: "The politics of envy will play no part in our plans. But we do need the politics of common sense."
The move to limit cash bonuses would be temporary and would work alongside the new agreement signed by the banks and the Financial Services Authority (FSA).
It would only apply to High Street retail banks, which means investment banks would be exempt.
However, the proposed change would apply to the investment arms of banks that also lend to consumers.
The head of the FSA, Lord Turner, expects banks to spell out soon how their bonuses will be divided up.
Byrne: "We are not taking Mr Osborne's advice to water down the toughest bonus rules in the world."
Liam Byrne, chief secretary to the Treasury, said: "Mr Osborne's hypocrisy beggars belief. The Tories have fought against every plan we've delivered to support jobs and businesses."
He added that the Conservative plans would "water down the toughest rules in the world", saying: "I can't understand the logic of that."
Liberal Democrat Treasury spokesman Vince Cable said: "The Tories have been deeply ambivalent on the much more fundamental question of what we do about the future of the banking system.
"They have not given full backing to [Bank of England governor] Mervyn King's proposals on splitting up the banks and these bonus proposals are short-term, stop-gap solutions designed to stem public anger but which fail to get to the heart of the problem."
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