RBS could create ‘bad bank’ for problem loans

Royal Bank of Scotland could create an internal bad bank to house more of its problem loans, even if Britain decides not to enforce a breakup of the part-nationalised lender, banking industry and political sources say.

Britain’s finance ministry, aided by investment bank Rothschild, is close to concluding a review into whether RBS, 81% owned by taxpayers, should be made to hive off its soured assets into a separate legal entity. It is expected to make its recommendations known in early October, sources said.

Analysts expect the Treasury to decide against recommending a breakup. They argue it is not needed since RBS has already wound down or sold off the vast majority of its bad loans and that European state aid rules and the need for approval from RBS’s minority investors would make the plan unworkable.

Advocates of a breakup, including former Bank of England governor Mervyn King and ex-UK finance minister Nigel Lawson, say it will leave the bank, rescued through a £45.5bn (€54bn) 2008 government bailout, better placed to lend and support the UK economy.

If the idea is rejected, RBS, which is intensely scrutinised by lawmakers and regulators, could try to appease critics by forming an internal bad bank without government intervention.

The bank is coming to the end of a five-year recovery plan overseen by chief executive Stephen Hester who will leave in October. At the start of 2009, Hester and restructuring chief Rory Cullinan identified £258bn of RBS’s most risky loans that would be sold off or wound down. Only £36-£38bn worth of those loans are expected to remain by the end of the year, RBS said in August.

New CEO Ross McEwan may decide to enlarge and revamp the non-core portfolio when he takes over in October, sources say, putting assets from the group’s Irish business, Ulster Bank, and more UK commercial real estate loans inside it.

When the good bank/bad bank split was mooted, RBS harboured hopes of reducing its Irish exposure by swapping some Ulster Bank assets for the UK assets of an Irish bank. But hopes of such a deal is fading.

A source with knowledge of RBS’s efforts told Reuters the bank had learned that the two most obvious candidates (Ireland’s National Asset Management Agency and Allied Irish Banks) would not take part in an asset swap.

An internal “bad bank” would house only assets which are being sold or wound down. As the assets are offloaded, the amount of capital the bank needs to hold is reduced, freeing up capital to lend to other customers.