George Osborne has vowed to fight an "anti-business culture" in the UK, warning that the row over bonuses and pay threatens to undermine the jobs and prosperity provided by the free market economy.

The Chancellor used a speech to the Federation of Small Businesses to defend the principle of "rewards for success".

"Let me say something about the row over bonuses and pay," he said.

"Of course we need to reform our banking system - and nobody has done more than this government to address the too-big-to-fail problem that so offends every taxpayer."

Speaking on Tuesday night, Osborne continued:"There are those who are trying to create an anti-business culture in Britain - and we have to stop them. At stake are not pay packages for a few but jobs and prosperity for the many."

But Labour hit back with shadow chief secretary to the Treasury Rachel Reeves saying: “As for creating an anti-business culture, George Osborne should look in the mirror. Under his watch the economy has gone into reverse, net lending to businesses is falling and in the last three months over 4,000 companies went under – up 7.2% in a year.

“Greater transparency, accountability and responsibility on top pay will give businesses more certainty and is the way to ensure we really do get rewards for success but not for failure."

The Chancellor's comments came as Labour sought to keep up the pressure on David Cameron over "excessive" City pay, using a House of Commons debate yesterday to demand a repeat of the tax on bankers' bonuses.

Shadow business secretary Chuka Umunna dismissed suggestions that Labour was being "anti-business" by focusing on the massive rewards handed out to some of those at the top of the financial sector.

Large bonuses in banks bailed out by the taxpayer should be paid only when they reflect "genuinely exceptional performance", he said.

But Treasury minister Mark Hoban told MPs that Labour was to blame for an unfettered "cash bonus culture" which took hold in the City during its 13 years in power.

The debate came as Royal Bank of Scotland chief executive Stephen Hester broke his silence over his decision to give up a bonus of almost £1 million in shares.

In a letter to the largely state-owned bank's staff, Hester said press coverage had been "discomforting to say the least", but insisted RBS was "making progress in the face of a difficult inheritance". The best way to deal with criticism was to "prove the critics wrong", he wrote.

Labour initially planned to use the opposition day in the Commons to force a vote on Hester's bonus. After the RBS boss waived the payout in response, leader Ed Miliband sought to keep the spotlight on the issue of pay by calling a debate on reform and responsibility in the banking industry.

Umunna said families and small businesses were suffering from the impact of austerity: "People have seen this extraordinary squeeze in their living standards, but as for the institutions and bankers right at the centre of the crisis that created these problems, those people now seem not only not to be suffering a gigantic squeeze on their living standards, but actually get continued very high remuneration, in part because the taxpayer has been forced to step in and bail them out."

Hoban told MPs that the coalition government was reforming regulation, taking action to stimulate lending and changing the rules on pay to keep bonuses down.

"We are remedying what the Chancellor has described as 'the biggest failure of economic management and banking regulation in our country's history' and that failure was presided over by the party opposite," said Hoban.

City bonuses tripled under Labour to £11.6 billion, but fell to £6.7 billion last year and are expected to fall further when banks make settlements with high-earning staff over the coming weeks, said Hoban.

David Hillman, spokesman for the Robin Hood Tax campaign, which is campaigning for a financial transaction tax, said: "It is high time the Government moved beyond rhetoric and token gestures and took concrete steps to tackle City excess."