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RBS avoids split as $61 billion toxic loans hived off

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The Royal Bank of Scotland has avoided being split in two and will instead hive off some $61 billion in toxic assets into an internal "bad" bank.

The U.K. lender, which is 81 percent owned by the British taxpayer since the bank was rescued in 2008, will ring-fence £38 billion ($60.9 billion) of bad assets - such as loans it does not expect to have repaid - that will be placed into a new Capital Resolution division in 2014. It announced the restructuring will free up between £10 billion to £11 billion of capital.

"We worked closely with HM Treasury and their advisers and identified a pool of £38 billion that we agreed would be a drag on our performance. These assets consume 20 percent of our capital and are made up predominantly of the most high risk assets we have in RBS," the bank said in its earnings report.

(Read more: Banks brace for billion-dollar forex probe)

The "bad bank" will manage the run-down of high-risk assets projected to be £38 billion by the end of 2013. The goal is to remove 55-70 percent of these assets over the next two years, it added.

"While there is inevitable uncertainty associated with running down such assets, there is a clear aspiration to remove all these assets from the balance sheet in three years," RBS said.

Chris Tinker, an equity strategist at Libra Investment Services in London said that it "makes sense for shareholders" and it improves the opportunity for the government to dispose of it.

Ulster Bank assets (approximately £9 billion) will be managed by the "bad bank", according to the bank, which will include commercial real estate and will be subject to a review. The internal bank will also have assets from U.K. Corporate, International Banking and Markets divisions.

The group announced that it will accelerate the divestment of Citizens, a U.S. banking subsidiary, and a partial initial public offering is now planned for 2014 and it intends to fully divest the business by the end of 2016.

Meanwhile, RBS reported third-quarter operating profit of £438 million, against £909 million for the third quarter of 2012. It reported a third-quarter pre-tax loss £634 million, after a £496 million accounting charge. It added that it expected a significant increase in impairments in the fourth quarter of 2013 in light of its new strategy which is likely to result in the group reporting a substantial loss for the full year.

Forex probe

A rise in litigation costs were also evident in its forward-looking statement. It said that investigations relating to the setting of LIBOR and other interest rates and foreign exchange trading activities are all possible factors that could effect future results.

(Read More: Barclays profit falls, cooperating in forex probe)

"Various governmental and regulatory authorities have commenced investigations into foreign exchange trading activities apparently involving multiple financial institutions. The Group has received enquiries from certain of these authorities including the FCA (Financial Conduct Authority). The Group is reviewing communications and procedures relating to certain currency exchange benchmark rates as well as foreign exchange trading activity and is cooperating with these investigations. At this stage, the Group cannot estimate reliably what effect, if any, the outcome of the investigation may have on the Group," it said.

The Financial Times reported on Friday that it had suspended two traders in connection with a currency manipulation probe, citing two people familiar with the situation.

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Independent review

In a busy day for the U.K. lender, it also reveled the results of an independent review it commissioned of its lending to small and medium sized businesses, carried out by Sir Andrew Large, former deputy Bank of England governor.

The report found that the bank had failed to meet its own targets and the expectations of its customers when it came to financing SMEs – which make the largest part of the UK economy and will need investment if the UK's nascent recovery is to be maintained.

"The picture Sir Andrew Large paints is not an entirely comfortable one, but it's one we have to confront," chief executive Ross McEwan said in a statement.

"The Large review shows that there is significantly more we can do to expand our lending to small and medium-sized businesses, " he said, adding that while its competitors had increase their lending, RBS was contracting.

"We will address all the issues this report raises."

(Read More: UBS profit beats but hurt by new capital demands)

Secretary of State for Business, Vince Cable, said he welcomed the announcement of new internal bad bank & selling its US bank.

"This will enable it to focus on business lending in the UK," he said in a statement.

"It is clear that for many years RBS has handicapped our recovery by failing to provide the credit that businesses need. As Sir Andrew Large demonstrates, its SME lending practices are badly designed for supporting small businesses. After these changes good British companies, especially SMEs, should expect a more positive approach."

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