Feb. 11 (Bloomberg) -- Royal Bank of Scotland Group Plc Chief Executive Officer Stephen Hester dismisses concerns that Prime Minister Gordon Brown wields too much power on behalf of the bank’s new controlling shareholder, the British taxpayer.

“I am not feeling pressure from the shareholder to act irrationally,” Hester told analysts on a conference call last month. “If I stood up and said, ‘You know what, our strategy is to close the U.K. and move to Bermuda and become a hedge fund,’ we might have a debate.”

That same day, even as Brown was railing against the dangers of financial protectionism, Hester pledged RBS would increase British lending by 6 billion pounds ($8.8 billion) and scale back business outside the U.K., which accounts for 41 percent of the bank’s lending. RBS has pulled out of loans to an Italian investment company and a German shipping line since December.

“In a tightening credit environment, the increase in RBS’s lending to U.K. customers will probably be roughly matched by a decrease in lending outside the U.K.,” said Sandy Chen, an analyst at London-based Panmure Gordon & Co, an amount equal to about 2 percent of the bank’s international loan book.

After record writedowns and losses, Edinburgh-based RBS, Citigroup Inc. and American International Group Inc. are among the financial firms starting to disassemble their global franchises after receiving government bailout funds.

Franchise Rethink

New York-based Citigroup, which received $45 billion from the U.S., plans to sell Japanese units, including NikkoCiti Trust & Banking Corp. AIG, the New York-based insurer founded 90 years ago in Shanghai, plans to sell more than two-thirds of its businesses, including its Asian life insurance unit. The U.S. arranged a $150 billion rescue package for AIG last year.

“As soon as nations own the banks, they get to direct the lending,” said David North, head of asset allocation at London- based Legal & General Group Plc, the largest investor in British stocks with more than 270 billion pounds of holdings. “Royal Bank of Scotland will start banking again where? In Scotland.”

U.K. domestic lending accounted for 46 percent of RBS’s 609 billion pounds of loans to customers in the first half of last year, company documents show. International banking transactions conducted through U.K. offices accounted for 13 percent, Europe for 20 percent, the U.S. for 14 percent, and Asia for 7 percent.

“Royal Bank of Scotland has to significantly reduce its balance sheet, and that means lending less,” Hester told a panel of lawmakers today. “We can do that through our international, global operations, and yet protect our U.K. customers and lend more to creditworthy sections of the U.K. That is our plan.”

Pulling Loans

Eight Italian banks agreed to replace RBS and Paris-based BNP Paribas SA in December as lenders to Carlo Tassara SpA, the Italian holding company of financier Romain Zaleski. RBS also plans to pull out of a loan to Hamburg-based Hapag-Lloyd when German travel-services company TUI AG sells the shipping line, two people with knowledge of the decision said last month.

Piers Townsend, a London-based spokesman for RBS, declined to comment on the loan pull-backs.

RBS expanded its balance sheet more than 20-fold to 1.73 trillion pounds under former CEO Fred Goodwin. As Europe’s biggest arranger of leveraged loans from 2004 to 2008, the bank helped finance takeovers of companies ranging from German broadcaster ProSiebenSat.1 Media AG to Spanish clothing retailer Cortefiel SA. The loans now trade below face value, implying a higher risk of default and potential losses to holders of debt.

ABN Amro Takeover

“The government’s investment in RBS means the bank will slim down and get rid of overseas assets,” said Julian Chillingworth, chief investment officer at London-based Rathbone Brothers Plc, which manages $21 billion. “It will undoubtedly be much more risk-averse.”

Deutsche Bank AG, Germany’s biggest bank, hasn’t received government investment and expects to benefit as rivals that did face “pressure to withdraw” from international markets, CEO Josef Ackermann said at a press conference in Frankfurt Feb. 5.

“It’s such an incredible advantage when you’re not feeling this pressure because you can decide freely,” he said. “A taxpayer wants to get the credit himself, instead of seeing it granted somewhere in South America or elsewhere in the world.”

RBS was involved in more than $140 billion of takeovers during the past decade in the U.S., Asia and Europe. Those included ABN Amro Holding NV of the Netherlands in 2007; a 5 percent stake in Bank of China Ltd. in 2005; and Cleveland-based Charter One Financial Inc. in 2004. The investment in the Beijing-based Bank was sold last month for $2.3 billion, loosening RBS’s foothold in the world’s most populous nation.

RBS also may sell units of ABN Amro to the Dutch government, Hendrieneke Bolhaar, a spokeswoman for the Netherlands finance ministry, said Feb. 2.

70 Percent Stake

Hester, 48, replaced the 50-year-old Goodwin in November after the U.K. government invested 20 billion pounds for a 58 percent stake in the bank. That holding may climb to 70 percent.

Goodwin and former RBS Chairman Tom McKillop apologized to a panel of lawmakers yesterday for acquisitions, including ABN Amro, that led to RBS’s near collapse. “I could not be more sorry,” Goodwin said.

John McFall, the Labour lawmaker who leads the Treasury Committee, questioned whether global banks like RBS are too large and complex to manage. “There have to be systemic problems here,” he said.

As Prime Minister Brown pushes RBS to lend more at home, he’s lecturing the rest of the world to keep lending abroad.

‘Very Nationalistic’

“The biggest danger that the world faces is a retreat into protectionism,” Brown said in Parliament on Feb. 4. “As a result of the withdrawal of foreign banking capacity in large numbers of countries, we face a downward spiral whereby these countries cannot borrow from anybody because foreign banks have left.”

Jane Coffey, who helps oversee $63 billion as head of equities at Royal London Asset Management Ltd., said Brown isn’t being consistent.

“The government’s key policy is to get the banks lending, and that means in the U.K.,” Coffey said. “They have become very nationalistic in their tone, despite Gordon Brown saying that what we need is a global solution. It is British jobs for British people.”

Brown’s statements may be explained by Britain’s need for capital from abroad. Foreign lenders accounted for more than half of new U.K. corporate loans and 45 percent of new mortgages during the past decade, U.K. Chancellor of the Exchequer Alistair Darling told Parliament on Jan. 19.

Lehman to GMAC

At the peak of the mortgage market in 2007, New York-based Lehman Brothers Holdings Inc. and GMAC-RFC, the British mortgage-lending unit of Detroit-based GMAC LLC, provided 13 billion pounds of residential mortgage loans in the U.K., according to the Council of Mortgage Lenders in London. That was more than HSBC Holdings Plc, Britain’s biggest bank, loaned to homeowners in the U.K. that year. New York-based Lehman went bankrupt in September, and GMAC, which received a $6 billion government bailout, pulled out of the U.K. market last year.

The British economy will shrink 2.8 percent this year, the most since 1946 and faster than any industrialized country, according to estimates from the International Monetary Fund.

Nationalization policies in banking could jeopardize Britain’s centuries-old role as a center for global finance, according to Ranald Michie, a professor of history at the University of Durham and author of The City of London Since 1850: Continuity and Change.

“A warning light has gone on,” Michie said. “For Britain, there is no national solution to this crisis.”

‘Wimbledonization’

London’s rise as a modern finance center accelerated in the 1980s under Prime Minister Margaret Thatcher. The city became the world leader in cross-border bank lending after Thatcher’s government introduced policies in 1986, known as the Big Bang, which allowed London Stock Exchange member firms to be bought by outsiders. Over the next two decades, international banks bought all of London’s major investment banks, including Schroders Plc and Cazenove Group Plc.

The policy of allowing non-U.K. banks to dominate London’s financial center was termed “Wimbledonization” by former Bank of England Governor Eddie George, because, as with the annual tennis competition, British players struggled to win.

“We provide the tournament venue, but the prizes are mostly carried off by competitors from overseas,” George said in 2001. “It is the activity rather than the nationality of ownership which creates a competitive marketplace.”

Shanghai Roots

Nationalized banks are problematic for international markets because the interests of governments and global capital don’t easily align, said Michael Marks, chairman of NewSmith Capital Partners LP in London and a former director of the London Stock Exchange Plc.

“Governments have got different agendas from international capital,” said Marks, whose Berkeley Square office features a black-and-white photograph of the London Stock Exchange’s old trading floor. “Government money carries with it social responsibilities, which may sound fine, but in the end are not necessarily the right thing for a commercial organization.”

HSBC, Barclays Plc and Standard Chartered Plc have so far avoided government investment. That may help preserve their international operations, Marks said.

“Government funding will restrict a bank’s future growth, direction and policies,” Marks said. “If you can avoid government money, why would you want it?”

HSBC, founded in Shanghai in 1856, is determined to remain a “strong universal bank,” Chairman Stephen Green said at the World Economic Forum in Davos, Switzerland, last month. “You need efficiently functioning international banks.”

Britain can’t afford to lose the wider battle for international capitalism, even as it gains more power over RBS and other lenders, NewSmith’s Marks said.

“A small trading nation like the U.K. has to be international in its outlook,” Marks said. “We’re really on a knife edge here. We need to make the right decisions.”

To contact the reporter on this story: Simon Clark in London at sclark4@bloomberg.netJon Menon at jmenon1@bloomberg.net

Last Updated: February 11, 2009 16:09 EST