Lib Dem peer leaves frontbench, saying of Project Merlin 'if this is robust action on bonuses, my name's Bob Diamond'

George Osborne's efforts to end the war on bankers are crumbling as Vince Cable, the business secretary, said he was still determined to end "unjustified and outrageous" salaries in the sector and his Liberal Democrat ally Lord Oakeshott left his party's frontbench after damning the government's attempts to curb bonuses.

Oakeshott, who was not in the government but spoke for the junior coalition partner on Treasury matters in the Lords, stood down shortly after he criticised officials working on the government's deal with the bankers and said: "If this is robust action on bank bonuses, my name's Bob Diamond."

Danny Alexander, the Lib Dem chief secretary to the Treasury, said Oakeshott had stood down by mutual consent.

Osborne hailed his deal as the moment to move beyond retribution to economic recovery.

Cable backed the deal – hammered out under the codename Project Merlin to cover issues such as lending, bonuses and pay disclosure – but then said the underlying cause of excessive bonuses would not be tackled until the report by the government commission into the future of banking, chaired by Sir John Vickers.

He described the bonuses announced on Wednesdayfor Stephen Hester, the chief executive of RBS, and Eric Daniels, the outgoing chief executive of Lloyds, as "extraordinarily wrong". Daniels is to be paid a £1.45m bonus on top of his salary of £1m and Hester £2.04m.

Cable said: "We have a fundamental problem of excessive profits in the banking system which has got be dealt with through structural reforms. We cannot continue to have a situation where banks continue to be underpinned by the taxpayer. That will deal with the problems of very large bonuses that are unacceptable".

Cable also stressed that the deal was for one year and said if the banks failed to meet their commitments the government reserved their right to reopen the agreement.

He had fought hard to prevent the banks trying to make the deal neuter the Vickers banking commission, he said.

Although the deal makes progress on lending to small businesses, it also clears the way for bank bosses to collect their bonuses for the first time since the banking crisis began in 2007.

Barclays boss, Bob Diamond, can now expect to collect a bonus of at least £8m and Stuart Gulliver of HSBC at least £9m. Oakeshott, a former City financier and a close ally of Cable's, had been scathing. Speaking while still a Liberal Democrat Treasury spokesman, he laid into the Treasury's negotiators saying: "They've got an awful combination of arrogance and incompetence, most of them couldn't negotiate themselves out of a paper bag."

Those remarks in particular are thought to have incensed ministerial colleagues.

Oakeshott told the Guardian: "I'm afraid the banks have taken the Treasury for a ride and I've decided I'm more comfortable saying that from the backbenches."

Ed Balls, the shadow chancellor, said: "It is a sad commentary on this Tory-led government that Lord Oakeshott has been forced to pay the price for daring to tell the truth."

In a Commons statement Osborne highlighted a new gross lending target signed by the four major banks and Santander to lend £76bn this year – a £10bn, or 15%, increase in commitments to lend to small and medium sized business. The absence of a net lending agreement was highlighted as a big omission by Labour, but Treasury officials said the lending deal showed Osborne had played hard ball, adding that "the £10bn figure was way above expectations".

Overall gross new lending to business, large and small, will increase from £179bn to £190bn. The four major banks have also committed an extra £1bn to the Business Growth Fund, and an additional £200m to capitalise the Big Society Bank, the government lending vehicle to support voluntary initiatives.

The chancellor announced that directors' pay would be linked to lending targets, and insisted that no more than £2,000 could be paid in cash bonuses at the bailed-out banks.

The bosses of the bailed-out banks will have their bonuses paid in shares and deferred until 2013 while the bonus pool for RBS's investment banking arm – known as RBS Global Banking and Markets – will be £950m in 2010, down on the £1.3bn in 2009. Banks will voluntarily publish the pay of the five highest paid executives outside the boardroom.

In reality this means that the highest paid bankers – the star traders and deal makers – will still not need to be covered by the new regime. The banker leading the Merlin talks, John Varley, told the Guardian: "They could be different. It is possible that the five highest paid senior executives don't coincide with the five highest paid people in the bank."

• This article was amended on 10 February 2011. The original said that Stuart Gulliver of HSBC could expect a bonus of at least £9bn. This has been corrected.