The financial watchdog has banned bonuses that are guaranteed for more than a year, as part of new rules determining how banks should pay and reward staff.
The Financial Services Authority (FSA) also said that senior employees should have their bonuses spread over three years, to discourage short-term risk taking, the BBC has reported.
Hector Sants, chief executive of the FSA, said the regulator was "determined that banks' remuneration policies should be consistent with, and promote, effective risk management".
Several new principles, to take effect two months later than expected, from January 2010, have been added to the FSA's financial regulation handbook. These include:
- Bonuses should only be guaranteed for 12 months
- Senior employees will see two-thirds of their bonuses paid out over three years.
However, the FSA has reduced the number of banks affected by the code from 47 to 26.
Jon Terry, partner and head of reward at professional services firm PricewaterhouseCoopers, warned there was a danger those banks not covered by the code would be able to attract better and more experienced staff as they were able to offer bigger rewards.
"As the code currently only applies to the largest financial institutions, there is a danger that a two-tier system of regulation will evolve, putting those that the code applies to at a competitive disadvantage – particularly in terms of recruiting and retaining top performers," he said.
He added the FSA had put "real pressure" on individual organisations to get compensation right, including linking the deferral of bonuses to the underlying business model and taking into account long- and short-term risks.
All banks covered by the code now have until the end of October to submit their remuneration policies to the FSA for approval. Banks that do not comply with the code could face enforcement action or be forced to hold more cash in reserve.
The FSA launched a consultation in February looking at measures to discourage excessive risk-taking and to crack down on huge bonuses linked to individual's performance regardless of the bank's success.