Business Secretary Vince Cable has said the government is willing to take "further action with tax on banks" if they do not increase lending to small and medium-sized enterprises (SMEs).
Mr Cable told MPs on the Business Committee that the level of lending to SMEs was a "serious problem".
Under the Project Merlin agreement, the UK's biggest banks are committed to lending £76bn in 2011 to SMEs.
The bosses of the four biggest banks have also given evidence to MPs.
The Treasury Committee heard their views on the Independent Commission on Banking's proposal to ring-fence the retail operations of a bank into distinct subsidiaries, so that these operations would be protected if a bank collapsed.
HSBC chairman Douglas Flint and Royal Bank of Scotland chief executive Stephen Hester were divided in their opinions about this.
Mr Flint told MPs he thought ring-fencing was required, but Mr Hester said: "I believe that creating a ring-fence increases some of the systemic risk and decreases some of the ability of banks to withstand the risk."
As well as disagreement over ring-fencing, there were opposing views over the value to the mega banks of the implicit guarantee from taxpayers that they will be bailed out in a crisis.
RBS, along with Lloyds, was bailed out by the government during the financial crisis, and is now 84%-owned by the government.
Mr Horta-Osorio, said these cheaper funds could be of benefit to big banks' investment banking operations, whereas Barclays Mr Diamond said this was not the case for his bank.
The BBC's Business Editor, Robert Peston, said the normally united front presented by big bankers was absent, and in fact they had a "bit of a scrap".
Big banks, big risk?
Mr Hester said that some taxpayers' money may have been used to pay bonuses.
"It could have fed through to bonuses," he said. "It is entirely possible."
Robert Peston said the remark would be viewed by some as scandalous - and others as a statement of the obvious.
Asked about the breaking up of big banks, Mr Hester said size did not matter.
A big bank did not pose a systemic risk, but a bank that took big risks did, he said.
HSBC's Mr Flint added: "I actually don't believe it would make a great deal of difference to competition. I don't believe for the consumer it would necessarily make so much of a difference."
Both RBS and Lloyds were told by the European Commission to sell hundreds of branches, 318 and 600 respectively, but the Independent Commission on Banking wants the government to force Lloyds to sell off even more branches.
Lloyds chief executive, Mr Horta-Osorio, said the 600 that he was selling would prove big enough to compete and it was not necessary to sell more: " Our board strongly believes this (extra branch sales) is against the interests of our shareholders, including taxpayers... there is overwhelming evidence this would be a serious and effective challenger."
In his evidence given in the morning, Mr Cable said: "The chancellor and prime minister have made it clear that if we don't get results, they have said we should take further action with tax on banks."
Sanctions could include a tax on profits, balance sheets or bonuses, he said.
But he also said it could be a problem if some banks met lending targets, while others did not.
Under Project Merlin, the amount the four biggest banks, plus Santander, agreed to lend to SMEs equates to £19bn a quarter. However, in the first three months of the year £16.8bn was lent.
Mr Cable acknowledged that while Project Merlin did not set specific quarterly targets, there was now a "catch-up element" involved.
He said there was a mixture of factors involved in why banks were not lending as much as the government wanted.
One was the level of demand - banks say it is weak, but businesses say they are being discouraged from applying in the first place.
The government's requirement that the banks hold more capital was also having an effect, he said, as banks were being more cautious in their lending.
He also said that banks had gradually moved away from "relationship banking", meaning that "at a time of crisis like this they don't have the infrastructure in place to assess the risk of lending to small business".
Mr Cable said if banks did not increase SME lending, the UK's economic recovery would suffer.
"We believe there is an issue with the supply and cost of finance and it is inhibiting recovery," he said. "Certainly, if it's not dealt with, it will inhibit recovery as we move into more rapid growth."
However, he added that he had anecdotal evidence that some banks were changing their behaviour, highlighting Lloyds as taking the issue very seriously and meeting their targets.
"Some banks are trying harder than others," he said, also singling out Santander for its efforts.