29 January 2012 Last updated at 05:38 ET 
Cabinet Minister Mr Duncan Smith told the BBC "nobody would be happier" than ministers if Mr Hester had declined it.
But it had been up to the RBS board - if they had quit, it would have had a huge impact, Mr Duncan Smith added.
Mr Hester took over as the Royal Bank of Scotland's chief executive in 2008 to replace Sir Fred Goodwin, after the bank had to be bailed out by the government.
'Can't interfere' Work and Pensions Secretary Mr Duncan Smith told BBC One's Andrew Marr programme that ministers had made it "very clear" to the board that they should take into consideration public concern, and that the bonus - to be paid in shares in 2014 - could be clawed back if he did not perform well.
He said Mr Hester's contract, drawn up under the previous Labour government, meant "the board takes the decision on this" and ministers could not "interfere and tell them what to do".
"If we didn't like that, of course the only option would be to get rid of the board. If you do that, imagine what would happen in the banking sector and imagine what would happen to RBS. You would have chaos.
"Remember RBS's balance sheet is as large, if not slightly larger, than the GDP of the UK. What would that do to ordinary people?"
He said the government had to get the bank to a point where it could be sold and the taxpayer repaid.
He said it was for Mr Hester "individually" to decide whether or not to take the bonus.
"As a member of the government, I don't have a collective opinion on that, but I must say to you: nobody would be happier than the government if he took such decisions. But it's up to him."
Duncan Smith: RBS bonus veto could have caused chaos
Mr Hester was appointed after RBS was bailed out by the taxpayer
Iain Duncan Smith has said there could have been "chaos" if ministers had overruled the board of RBS and vetoed a £963,000 share bonus for its boss.
The government has come under pressure to act over Stephen Hester's bonus, as it owns 82% of the bank's shares.Cabinet Minister Mr Duncan Smith told the BBC "nobody would be happier" than ministers if Mr Hester had declined it.
But it had been up to the RBS board - if they had quit, it would have had a huge impact, Mr Duncan Smith added.
Mr Hester took over as the Royal Bank of Scotland's chief executive in 2008 to replace Sir Fred Goodwin, after the bank had to be bailed out by the government.
'Can't interfere' Work and Pensions Secretary Mr Duncan Smith told BBC One's Andrew Marr programme that ministers had made it "very clear" to the board that they should take into consideration public concern, and that the bonus - to be paid in shares in 2014 - could be clawed back if he did not perform well.
He said Mr Hester's contract, drawn up under the previous Labour government, meant "the board takes the decision on this" and ministers could not "interfere and tell them what to do".
"If we didn't like that, of course the only option would be to get rid of the board. If you do that, imagine what would happen in the banking sector and imagine what would happen to RBS. You would have chaos.
"Remember RBS's balance sheet is as large, if not slightly larger, than the GDP of the UK. What would that do to ordinary people?"
He said the government had to get the bank to a point where it could be sold and the taxpayer repaid.
He said it was for Mr Hester "individually" to decide whether or not to take the bonus.
"As a member of the government, I don't have a collective opinion on that, but I must say to you: nobody would be happier than the government if he took such decisions. But it's up to him."
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