Nov. 28 (Bloomberg) -- Royal Bank of Scotland Group Plc will sell the government almost 20 billion pounds ($31 billion) of stock and a majority stake after shareholders bought just 0.2 percent of the equity offered in the U.K.’s biggest bailout.

Investors took 56 million shares at 65.5 pence apiece, Edinburgh-based bank said today in a statement. Britain will buy the remaining 22.9 billion common shares offered by RBS, giving it a 58 percent stake, as well as 5 billion pounds of preferred stock. RBS rose 0.6 percent to 55.3 pence, leaving the government with a paper loss of 2.3 billion pounds.

RBS, Lloyds TSB Group Plc and HBOS Plc agreed to sell 37 billion pounds of stock under Prime Minister Gordon Brown’s plan to shore up capital in the British banking system. While RBS investors approved the bailout, most declined to buy shares offered at 16 percent above yesterday’s closing price. Brown wants to increase lending to small business and homebuyers to counteract the worst recession for 17 years and return RBS to private ownership as soon as possible.

“It’s a difficult balancing act,” said Simon Willis, a London-based analyst at NCB Stockbrokers Ltd. who has an “accumulate” rating on RBS. “The government has got to maintain lending to stop a downward spiral in the economy, but that may contradict the best interests of profit for banks.”

First Annual Loss

The government’s stake “supports financial stability, protects ordinary savers, depositors, businesses and borrowers while safeguarding the interests of the taxpayer,” a Treasury spokesman said in an e-mailed statement.

RBS, Britain’s second-biggest bank before it lost 85 percent of market value this year, may post its first annual loss in 40 years as bad loans increase, the company said this month. The bank has posted more than 7 billion pounds of credit losses this year and probably will take more writedowns in the fourth quarter, Chief Executive Officer Stephen Hester said earlier this month.

“We regret that existing shareholders didn’t take up their pre-emptive rights but understand that market sentiment toward the banking sector made this uneconomic in the short term,” Hester said in an e-mailed statement.

RBS will be run “at arm’s length from the government,” Chancellor Alistair Darling said last month. Still, the government “will put people onto the boards, and they’re there to protect the taxpayers’ interests,” he said in an interview with Sky News. Under the terms of the recapitalization, banks will have to resume lending to customers at “at 2007 levels” for at least three years and help homeowners struggling to pay mortgages, the Treasury said.

‘Conflicting Signals’

“The government is giving conflicting signals,” said Alex Potter, a London-based analyst at Collins Stewart, who has a “hold” rating on RBS.

Bank of England Governor Mervyn King said this week that British banks may need more capital as the country heads for its worst recession since 1991. RBS, which is taking almost half the U.K. bailout funds, will need to top up the state aid with cash from its businesses to manage the economic slowdown, said Simon Maughan, a London-based analyst at MF Global Securities Ltd. who has a who has a “buy” rating on the stock.

Hester’s predecessor Goodwin used leveraged loans, securities trading and $90 billion of acquisitions to turn RBS into one of the biggest banks in the world during eight years as CEO. His 14.3 billion-euro acquisition of ABN Amro Holding NV last year, part of the world’s biggest banking takeover, triggered a third of the bank’s first-half writedowns and eroded capital.

Asset Sales

Fire sales of assets are unlikely to be on Hester’s agenda, said George Mathewson, the former CEO of RBS who campaigned to keep HBOS Plc independent last month. “Selling them because you need to sell is not the answer,” he said in an interview. Mathewson, who owns shares in the bank, waived his rights to the latest offering.

The bank raised 12.3 billion pounds in an earlier offering in June, selling stock to investors at 200 pence apiece, more than three times yesterday’s market price.

HBOS and Lloyds TSB also trade below the price at which they plan to sell shares. That means the government could end up owning almost 44 percent of the merged company. HBOS is selling 11.5 billion pounds of shares backed by the government. Lloyds TSB, which may take as much as 5.5 billion pounds of state funds, got shareholder backing for its stock sale on Nov. 19.

To contact the reporter on this story: Kevin Crowley in London at kcrowley1@bloomberg.net; Ben Livesey in London at blivesey@bloomberg.net.

Last Updated: November 28, 2008 11:58 EST