* Deal removes an obstacle to bank's eventual privatisation
* Deadline for Williams & Glyn IPO extended to end 2016
* UK's Osborne says agreement an 'important step'
* RBS CEO says deal is a 'vote of confidence' in the bank (Adds comments from RBS CEO, UK finance minister)
By Matt Scuffham
LONDON, April 9 Royal Bank of Scotland has agreed to pay 1.5 billion pounds ($2.5 billion) to cancel an arrangement that gives the government priority over dividends, clearing an obstacle to the lender's eventual privatisation.
The agreement between part-nationalised RBS and Britain's finance ministry to cancel the dividend access share (DAS), which gives the state priority over dividend payments and makes the stock less attractive to private investors, was approved by European regulators on Wednesday.
It had been put in place after Britain pumped 45.8 billion pounds into RBS during the 2008/9 financial crisis, leaving the government with an 81 percent shareholding.
"This is another important step on the road to a more resilient banking system and in dealing with the problems of the past to get taxpayers' money back," Britain's finance minister George Osborne said in a statement.
The figure of 1.5 billion pounds was in line with what UK Financial Investments, which manages the government's stake in RBS, had previously indicated the agreement was worth.
RBS said the cancellation of DAS would enable it to state more clearly its future dividend policy to existing and potential investors. But it said it had no intention to resume dividends in the short term.
The agreement requires approval by RBS's minority shareholders at the bank's annual meeting which is expected to take place in June.
"Today's agreement is a vote of confidence in the progress we have made in rebuilding RBS and in our plan for the bank's future," Chief Executive Ross McEwan said in a statement. "We now need to get on with building an RBS that can earn the trust of our customers and help change UK banking for the better."
McEwan is battling to turn around the bank, which has been plagued by past misconduct issues and remains three to five years away from a return to full private ownership, according to banking and political sources.
European regulators have also granted the bank extra time to sell 315 branches it has re-branded Williams & Glyn, and which it was forced to sell as a condition of its bailout in a move designed to increase competition among UK banks.
The bank failed to meet its initial deadline of selling the business by the end of 2013 after a sale to Santander collapsed in 2012. It now intends to float the business on the London Stock Exchange.
European regulators have set a new timetable for RBS to start selling the shares by the end of 2016 and to dispose of its entire interest by the end of 2017.
The commission said it agreed to extend the deadline because UK authorities and RBS had come up with a plan that would enable Williams & Glyn to become a "solid standalone bank".
As part of the new agreement, RBS also reiterated its plan to sell its U.S. retail business, Citizens, by the end of 2016.
Shares in RBS closed on Wednesday at 309.8 pence, meaning taxpayers are currently sitting on a loss of nearly 18 billion pounds following the government bailout.
In contrast, the government has begun to sell its shares in Lloyds Banking Group, which it also bailed out during the financial crisis and which is expected to return to private ownership before the election in May 2015. ($1 = 0.5971 British pounds) (Additional reporting by Barbara Lewis in Brussels; Editing by Robert-Jan Bartunek, Simon Jessop and Susan Fenton)