RBS Split Urged as Option for Cameron by Lawmakers: U.K. Credit

The U.K. government should consider breaking up Royal Bank of Scotland Group Plc and hiving off its toxic assets into a “bad bank,” lawmakers said in a report that suggests the lender isn’t ready to return to private hands.

“The government should immediately announce a process for considering alternative strategies for the future of RBS, including splitting the bank and putting its bad assets in a separate legal entity,” the Parliamentary Commission on Banking Standards said in its final report published in London today. It urged the government to carry out a “detailed analysis” and report by September.

Chancellor of the Exchequer George Osborne has said he doesn’t favor breaking up RBS, which is 81 percent owned by the government, partly because a full nationalization costing billions of pounds of public money would be required. Osborne will set out his plans for RBS and Lloyds Banking Group Plc, which is 39 percent state-owned, in his Mansion House speech later today.

Perceptions of RBS’s creditworthiness have worsened since the departure of Chief Executive Officer Stephen Hester was announced last week. Credit-default swaps covering RBS senior bonds for five years cost 198.5 basis points, up from 168 basis points at the end of last month. CDS for Lloyds debt are priced at 152.8 basis points compared with 148.7 on May 31.

Biggest Bailout

RBS, based in Edinburgh, was bailed out during the global financial crisis in 2008 and 2009 in a 45.5 billion-pound ($71 billion) rescue, the costliest ever for the banking industry.

The timetable for privatizing RBS was thrown into question when Hester said he plans to quit before the end of the year at the request of the board, instead of presiding over the exit from state ownership as he had hoped. No successor has been named. RBS will have completed most of its restructuring next year, allowing the government to start reducing its stake by the end of 2014, Chairman Philip Hampton said last month.

Prime Minister David Cameron said in an interview after Hester quit that U.K. voters are more interested in getting their money back from RBS than in its quick return to the private sector.

Today’s report calls for a fresh look at the current strategy for returning RBS to the private sector. The bank’s “capital position remains weak, impairing its ability to provide the levels of lending or competition needed for the restoration of vitality to the banking sector and for the U.K.’s full economic recovery,” the commission said. The bank also “continues to be weighed down by uncertainty over legacy bad assets and by having the government as its main shareholder.”

Extra Yield

The extra yield investors demand to hold RBS $2 billion of 2.55 percent notes due September 2015 rather than government securities rose today to the highest since Feb. 12.

The cross-party banking commission said the case for restructuring Lloyds, Britain’s biggest mortgage lender, was weaker.

Lloyds “has suffered far less from the effect of public ownership and the perception of political interference than RBS,” the lawmakers said. “Lloyds appears better placed to return to the private sector without additional restructuring.”

RBS closed yesterday at 323 pence a share, below the 407 pence where the government says taxpayers break even. Lloyds closed at 62.18 pence, just above the 61-pence-per-share cost of the state bailout. Osborne has vowed taxpayers will recoup their investment in the two banks, which required 65.8 billion pounds of public money to keep them afloat.

King’s View

Bank of England Governor Mervyn King, who steps down at the end of the month, urged in March that RBS be split into a good bank that could fund itself and a bad bank containing unprofitable assets, with the government taking the loss. Osborne has said he isn’t persuaded, and wants to transform the bank into an institution focused on increasing credit to U.K. companies and households.

Splitting RBS could lead to “significant advantages” by “focusing the good bank on U.K. retail and commercial banking and, by freeing it from legacy problems, strengthening its ability to lend,” said the commission. A split would make RBS “a more attractive investment proposition which could subsequently be privatized at a good price,” it said.

The commission also said the government should consider whether a split would lead to a quicker privatization of the good bank, examine which assets would go into the good and bad banks and evaluate costs to the taxpayer accordingly.

Separation Obstacles

“If the operational and legal obstacles to a good bank/bad bank split are insuperable, the government should tell Parliament why and submit its analysis to scrutiny,” the report said. “The government should also examine and report to Parliament on the scope for disposing of any RBS good bank as multiple entities rather than one large bank, to support the emergence of a more diverse and competitive retail banking market.”

RBS spokesman Michael Strachan declined to comment on the report, which also proposed deferring bonuses for senior bankers for up to a decade and making “reckless” management of banks a crime punishable with prison terms.

“We need to clarify which particular senior banker is responsible for which risk,” Andrew Tyrie, the commission chairman, told BBC Radio 4 today. “That’s what went wrong last time. It was, as we put it, the ‘Murder on the Orient Express’ defense. Everyone had some small contribution in the death, so nobody was responsible.”

The Treasury praised the report as “a very impressive piece of work” and promised to respond before Parliament breaks for the summer in mid-July. If legislation is required, the Banking Bill currently being considered by lawmakers can be amended, it said in a statement.

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