By Matt Scuffham and David Milliken
LONDON, June 19 Britain is ready to start selling its shares in Lloyds Banking Group and will examine whether to break up Royal Bank of Scotland, Finance Minister George Osborne said on Wednesday, after acknowledging the re-privatisation of RBS remains a long way off.
The government is keen to show Britain's part-nationalised banks are recovering from the 2008 financial crisis and a profitable sale of part of its 39 percent stake in Lloyds would allow it to claim at least partial success ahead of the next election in 2015.
Royal Bank of Scotland, still lumbered with toxic loans from a boom-era property binge in the UK and Ireland and buffeted by its role in a global interest rate-fixing scandal, remains a thorn in the side of the government and the wider economy, which is struggling to recover.
In his annual address to London's financial elite, Osborne said RBS probably should have been split into a good bank and its soured assets hived off into a so-called "bad bank" in 2008 when the lender was close to collapse.
"I can tell you today that we will urgently investigate the case for taking the bad assets - those mistakes of the past - out of RBS," Osborne told the audience in the Mansion House, the residence of the mayor of London's financial district.
"We will judge whether this will allow the bank to focus on its future supporting the British economy. We will see whether it's right for Britain to, in effect, see RBS broken up."
Osborne had previously dismissed splitting up RBS as too costly and disruptive. Similar "bad bank" solutions in Ireland and Spain triggered large losses that the state had to fill.
MORE CALLS FOR BREAKUP
His decision to investigate a restructuring of RBS comes after a parliamentary commission he appointed to look at the UK banking industry recommended such an analysis earlier on Wednesday.
Mervyn King, the outgoing governor of the Bank of England, and Nigel Lawson, a former finance minister and fellow Conservative party member, also have urged a breakup to hasten the privatisation of RBS.
Speaking just after Osborne at the Mansion House, King welcomed the government's plans but said more needed to be done to restore Britain's banking system to full health.
On Thursday the BoE's regulatory arm will publish details of how much new capital Britain's banks need to raise, with media reports suggesting that Lloyds, RBS and Barclays will bear the brunt of a previously announced 25 billion pound gap.
"There is clearly some way to go before we can claim to have a really well-capitalised banking system," King said, rejecting some banks' view that higher capital requirements are acting as a brake on their ability to support the economy.
A longer-term problem was the size of some British banks, which are still too large and complex to be allowed to collapse without causing financial chaos, King said.
The combined balance sheet of Britain's largest banks is still five times the size of the economy, despite years of post-crisis down-sizing, King said.
"We must restore trust in our banking system," he said. "It is not in our national interest to have banks that are too big to fail, too big to jail, or simply too big. Solving these problems is the work of a generation."
Britain's government said on Wednesday it would introduce criminal penalties for reckless bankers after a wide-ranging review into the industry by parliamentarians.
Osborne said a break-up of RBS would only happen if it was in the best interests of taxpayers and did not require them to put additional capital into the bank.
The review, which will be completed in the autumn, marks another jolt for Royal Bank of Scotland, whose chief executive, Stephen Hester, was ousted last week with Osborne's approval.
The parliamentary commission on banking standards set up by Osborne criticised the government for interfering in the running of RBS and said UKFI, the body that manages the government's stakes in the banks, should be abolished. Osborne said he disagreed.
Hester had opposed splitting up the bank, arguing that his restructuring plan, which has seen the balance sheet shrunk by 900 billion pounds since 2008, was dealing with the bad loans.
Osborne praised Hester's leadership in his speech, drawing applause from the audience.
Some analysts doubted the RBS review would change Osborne's mind.
"I think the bank has been run on a good bank/bad bank basis since 2009," said Mike Trippitt, an analyst at Numis Bank. "I think the government will come back and say we have considered it and the answer is 'no.' I don't think it is worth pursuing.
"There will be only about 40 billion pounds of assets in the non-core part of the business by the end of this year."
The head of Britain's largest industry body criticised the review, saying it would create uncertainty when the economy needed lending and growth.
"RBS is already well down the road of restructuring, so the case for a split into good and bad banks feels like groundhog day to me and I don't see how it would help taxpayers in getting their money back," said John Cridland, director general of UK business lobby, CBI.
RBS said it welcomed any proposal that speeded its return to private ownership.
"Ultimately any change to our strategy would need to be in the interests of all shareholders," Chairman Philip Hampton said in a statement.
The government pumped a combined 66 billion pounds ($103 billion) into the banks to keep them afloat during the 2008 financial crisis leaving it with an 81 percent shareholding in RBS and 39 percent of Lloyds.
Osborne said the government was willing to discuss how RBS can buy its way out of a dividend access share, which gives the state priority over dividends and has been seen as a major obstacle to privatisation, once the review into the bank's future had concluded.
While the government is sitting on a paper loss of nearly 10 billion pounds on its stake in RBS, shares in Lloyds are already trading above the government's break-even price of 61.2 pence, having been the top performer in the FTSE-100 last year.
Osborne said the government was actively considering options for selling shares in Lloyds. He said the first sale would likely be to institutions, such as pension funds, but it would consider all options for subsequent sales, including selling shares to the public.
A spokesman for Lloyds said the plan was a matter for the government and declined further comment.