Chancellor Alistair Darling has announced a review of the way banks are run after it was reported that Royal Bank of Scotland – being propped up by £20billion of public cash – is to pay out £1billion in bonuses.

The Chancellor said on Sunday that banks must recognise their duty to the public and warned bosses they should not reward "excessive risk-taking". He has also urged board members to ask tougher questions of their executives.

Mr Darling unveiled the inquiry as it was reported that RBS was in talks over the massive package with the body set up to manage the taxpayers' stake in bailed-out banks.

The claims over the scale of the payouts, made in the Sunday Telegraph newspaper, came just days after Gordon Brown warned RBS there should be "no rewards for failure" amid mounting anger over banks' behaviour.

RBS chiefs were said to be aiming to stem outrage by limiting the cash element being paid to each employee to £25,000 with the rest made up in shares in the bank.

Most of the share options would be deferred or withheld if the employee left within a set period or if their part of the bank made "significant" losses in the next two years, the paper said.

Around half of the total would be "discretionary" payments with the rest of the money RBS is "contractually" obliged to give to employees of ABN Amro, the Dutch bank bought by RBS.

The total payout would be around 60 percent lower than last year's.

RBS, now 68% owned by the UK Government, is due to report its 2008 results in three weeks, when it will confirm a loss of several billion pounds.

A spokeswoman said that the board was "yet to make a decision on remuneration policy for the year".

Writing in the Sunday Telegraph, Mr Darling said proposals to reform financial regulation would be published in the spring.

He said: "I am now setting up a review which will examine how banks are managed. Bank boards have a duty to ask more searching questions of their executives - when times are good as well as when they turn bad.

"I expect the review to make recommendations about the effectiveness of risk-management by banks' boards, including how pay affects risk-taking. It will also look at how boards operate, at the balance of skills, the role of institutional investors, and whether our approach is consistent with international best practice.

"Of course, no government should try to remove risk-taking from the system.  Nor would we want to. But government can act to protect people when excessive risk-taking threatens us all."

He added: "I know people feel angry about excessive bank bonuses. And directors have a duty to ensure that their banks behave responsibly.

"People who work hard should be rewarded for their effort. But it would be wrong to reward people whose excessive risk-taking brought the banks down, causing misery to millions of their customers.

"If there is one thing that we have learnt from the current crisis, it is that we cannot allow the risky decisions of banks to turn into a gamble with the futures of the very people who rely on them."

Liberal Democrat Treasury spokesman Vince Cable said the RBS bonuses should be halted.

He said: "This is unbelievably crass and irresponsible behaviour by people who have learned absolutely nothing and appear to have no standards of honesty whatsoever.

"All the bonuses should be frozen and no cash payments should be made under any circumstances."