UPDATE 3-RBS braces for challenging Q4, UK bank tax hit

* Q3 operating loss of 132 mln stg vs Q2 profit of 869 mln

* Says core bank becoming stronger

* Expects Q4 market environment to remain challenging

* Says UK bank levy to cost up to 250 mln stg in 2011

* Shares give up initial gains, fall by 3 percent

(Adds comments from CEO, analyst, fund manager)

By Sudip Kar-Gupta

LONDON, Nov 5 (Reuters) - Royal Bank of Scotland RBS.L expects challenging market conditions in the fourth quarter, and the part-nationalised British bank said a UK bank tax would add up to 250 million pounds to costs next year.

“There are inevitably clouds still out there on the horizon. We don’t see it raining hard but we still see the clouds -- we’ve got our raincoats on,” Chief Executive Stephen Hester told reporters.

RBS, which is 83 percent-owned by the UK government, reported a third-quarter operating loss of 132 million pounds ($213 million) on Friday -- down from a second-quarter profit of 869 million.

The bank is battling to recover from major losses from the credit crisis, and also faces political pressure on its investment banking arm, with governments keen to ensure that banks do not use state aid to pay out large bonuses to staff.

RBS’ earnings were hit by a charge of 858 million pounds in relation to movements in the fair value of the group’s own debt, reflecting volatility in the value of RBS bonds.

RBS said that excluding this, operating profit was 726 million pounds in the third quarter, helped by a 21 percent drop in bad debts compared to the second quarter.

RBS shares initially rose as much as 3.9 percent at the start of trading, but the stock then erased those gains and was down 3.20 percent at 45.63 pence by 1040 GMT.

“The figures were reasonable enough. The patient is getting better but they’re not out of the woods yet,” said Cavendish Asset Management fund manager Paul Mumford, who holds around 1.5 million RBS shares.


The third quarter has proved tough for many banks, which are under pressure from governments to curb bonuses and strengthen their capital base after being blamed for the credit crisis.

Concerns about problem loans overshadowed rival part-nationalised British bank Lloyds LLOY.L [ID:nLDE6A00YY], while Deutsche Bank DBKGn.DE and Bank of America also made losses in the third quarter. [ID: nLDE69Q05C] [ID:nN18152030]

Europe's biggest bank HSBC HSBA.L also gave a trading update on Friday, which said profits so far this year were "well ahead" of 2009. [ID:nLDE6A409P]

The British government has imposed a tax on the banking industry [ID:nLDE69K128], which RBS said would cost it 225 million to 250 million pounds next year, rising to 350 million to 400 million pounds in 2012.

RBS and other banks also face further uncertainty from an enquiry from Britain’s Independent Commission on Banking (ICB) on whether or not big banks should be broken up.

“It’s certainly true that the ICB does cast a cloud over UK banks for the next year,” said RBS CEO Hester.


RBS had to be rescued in October 2008 because of the credit crisis and its part in the 2007 takeover of Dutch bank ABN AMRO.

The bank was propped up with 20 billion pounds of taxpayers’ money, causing the eventual resignation of then chief executive Sir Fred Goodwin, pivotal in an aggressive acquisition strategy.

RBS, whose core Tier 1 capital ratio slipped to 10.2 percent from 10.5 percent at the end of the second quarter, has also been told by regulators to sell billions of pounds in assets in return for its state bail-out.

Sources told Reuters earlier this week that RBS was in talks to sell a $6.4 billion project finance book to Japan's Mitsubishi UFJ Financial 8306.T, and RBS is also looking to sell or float its insurance division.[ID:nLDE69R1P7]

RBS Finance Director Bruce Van Saun told reporters that the bank was hoping that its insurance arm would have better results in 2011, setting it up for a sale or spin-off in 2012.

RBS said its core business was becoming stronger, although the fourth quarter would remain challenging for its investment banking arm, which had a 21 percent fall in profits and has lost staff to rivals.

“It remains the case that the departures of our higher performing people are running at a rate which we find uncomfortable,” said Hester. (Additional reporting by Steve Slater; Editing by Jon Loades-Carter and Jane Merriman)