The European Court of Justice found that the rule the limits bankers bonuses to 100 percent of their salaries, or 200 percent if shareholders approve is valid.

Chancellor George Osborne said he had recognised the challenge was “now unlikely to succeed”.  The Treasury had argued that the cap would drive talent out of Europe and inflate basic pay, making it harder for banks to trim costs in lean years.

“I’m not going to spend taxpayers’ money on a legal challenge now unlikely to succeed,” Mr Osborne said.

But he added: “The fact remains these are badly designed rules that are pushing up bankers’ pay not reducing it. These rules may be legal but they are entirely self-defeating, so we need to find another way to end rewards for failure in our banks.”

The cap on the ratio is designed to reduce incentives for bankers to take excessive risks, but critics say it will push up basic pay and banks’ costs.

Mr Osborne also wrote a letter to Bank of England governor Mark Carney, in which he said that although the Treasury was abandoning its challenge, it “should not stop us from pursuing our objective of ensuring a system of remuneration that encourages responsibility instead of undermining it”.

“Ensuring that firms incentivise employees to behave in the right way is essential to restoring public trust in financial markets,” he added.

Mr Carney had himself voiced concerns about the EU measure, saying it had the “undesirable side-effect of limiting the scope for remuneration to be cut back”.