Oct. 22 (Bloomberg) -- U.K. banks must bolster their capital cushions before they pay bonuses, the head of Britain’s financial regulator said.

Higher capital ratios forced on banks will reduce lending and increase borrowing costs, Financial Services Authority Chairman Adair Turner said today in a paper. If banks first put employee-bonus payments toward building capital, the cost of credit won’t increase, he said.

The U.K. is seeking to quell public anger over a bailout that is saddling taxpayers with potential liabilities equivalent to a year’s economic output in the U.K. The Centre for Economics & Business Research Ltd. said in a report yesterday that bonuses for financial-services employees may rise by 50 percent to 6 billion pounds ($9.9 billion) this year.

“We need to look at those figures, and we will be talking to the banks whether those bonus accruals are compatible with the levels of capital build-up that we feel are appropriate,” Turner told journalists today. “It’s not legitimate for us to say: no bonuses.”

Treasury Minister Paul Myners yesterday told banks they had a “social obligation to the taxpayers.”

Banks must present their bonus plans to the FSA by the end of the month to see if they comply with a code published in August. The five biggest British banks last month agreed to comply with the code, and the U.K. units of overseas-based banks followed suit last week.

Turner’s report set out ideas for how to regulate banks deemed too big to fail. They should be subject to higher capital rules or higher taxes and be forced to write plans on how they would be split up in the event of a failure, he said.

To contact the reporters on this story: Caroline Binham in London at cbinham@bloomberg.netAndrew Macaskill in London at amacaskill@bloomberg.net

Last Updated: October 22, 2009 11:14 EDT