Chancellor files legal challenge to EU cap on bank bonuses However the Treasury fears that were the directive to become law, banks would simply be forced to raise base salaries in order to meet compensation demands. The challenge points out that the bonus cap has the potential to make the banking sector less sound from a prudential perspective as it will simply increase fixed costs. The challenge has been made on six key points, including that the cap is unfit for purpose, that is is based on invalid legality, and that it is an unlawful delegation of tasks to the European Banking Authority. The Treasury also fears that the proposals are being rushed into place without the necessary legislation having been finalised. In March, Mr Osborne looked isolated when all other 26 European Union finance ministers insisted they would press on proposals to curb bonuses. At a meeting in Brussels he said he would not be able to back the plans, which he believes could damage London's role as an international financial centre. Mr Osborne is not alone in thinking that the proposed cap is a bad idea. At a Treasury Select Committee hearing earlier this year, Andrew Bailey, head of the Prudential Regulatory Authority, said that the cap would reduce "discipline" in the system but would not reduce overall compensation. The EU directive has, firstly, the effect of increasing fixed remuneration as fixed a way to get out of the ratio bind that is cash out of the door to start with. Secondly, of course, remuneration is not deferred; so it reduces the power to use that incentivising mechanism," Mr Bailey told the Commons committee. Simon Lewis, chief executive of the Association for Financial Markets in Europe, which lobbies on behalf of major banks, backed the Chancellor's actions, saying: "The banking industry has already made, and continues to make, progress in changing remuneration policies and addressing the issues around variable pay and its relationship to performance and risk. "We believe that the remuneration provisions in CRD4 would add nothing more in tackling these issues and would have a number of unintended and negative consequences for Europe's banks," he continued. Treasury sources indicated that the UK has been at the forefront of tackling unacceptable pay packages at a number of international forums, including the G20 and the Financial Stability Board. The same sources also pointed to the PRA and the Financial Conduct Authority's code on bank remuneration, insisting they are among the tightest in the international community. A Treasury spokesman said: "Britain has been at the forefront of global reforms to make banking more responsible, including big reductions in upfront cash bonuses and linking rewards to long-term success. "These latest EU rules on bonuses, rushed through without any assessment of their impact, will undermine all of this by pushing bankers" fixed pay up rather than down, which will make banks themselves riskier rather than safer. In other words, as the Chancellor has said, they may undermine responsibility in the banking system rather than promote it. He went on to say that regulation of pay goes beyond the EU Treaty, explaining that the challenge is designed to "ensure the legislation respects the EU Treaty."