|The City regulator has told the boss of Royal Bank of Scotland (RBS) that he should consider selling its giant US retail bank and shrinking its controversial investment banking operations.
I have learned that the Financial Services Authority (FSA) has informed the taxpayer-backed lender that it is satisfied that RBS should be allowed to leave a massive state support scheme but warned it of the need for continued vigilance over the bank's financial health.
The message from the FSA came in a letter sent last week by Andrew Bailey, managing director of the FSA, to Stephen Hester, RBS's chief executive.
FSA insiders said that Mr Bailey told Mr Hester that selling Citizens, its US banking arm, and radically reducing the size of its global banking and markets operation could be helpful in bolstering RBS's capital position.
The communication, which fell short of a direct instruction from the FSA, was made as part of a broader message signalling the regulator's approval for RBS's exit from the Asset Protection Scheme (APS), which was established in 2008 to insure the bank against losses on more than £275bn of toxic assets.
The Treasury, FSA and RBS could announce as soon as tomorrow that the lender will exit the scheme after satisfying regulators and the Government that there are no circumstances under which it would credibly make a claim using the APS scheme.
RBS's exit from the APS is expected to be positioned as a milestone in RBS's recovery by politicians and the bank. Selling shares owned by the taxpayer remains some way off, but this week's exit from the APS was a prerequisite for ministers to begin contemplating such a move.
Mr Bailey's letter echoed the sentiment expressed to RBS about its structure by UK Financial Investments (UKFI), the body which manages the taxpayer's 82% stake in the bank, according to a source close to the regulator. As Sky News reported earlier this month, UKFI had also told RBS executives that selling Citizens and shrinking the GBM business would be viewed positively.
UKFI has a mandate to operate at arm's length from the Treasury and with an obligation to maximise returns to taxpayers.
George Osborne, the Chancellor, has made it clear privately that he would like RBS to refocus on lending to British homeowners and businesses.
Since RBS was bailed out by taxpayers with a £45bn capital injection in 2008, the bank has been forced to sign up to lending targets and has grown its share of UK lending significantly, none of which has assuaged criticism of RBS from politicians or the media.
RBS has already taken an axe to large swathes of its investment bank, selling or closing its operations in some countries, withdrawing from many product areas and making tens of thousands of redundancies.
The latest intervention from the FSA comes as regulators continue to emphasise the need for British banks to strengthen their capital bases. There remain concerns that with the Eurozone crisis far from resolved, a further shock to the banking system could rapidly erode lenders' core tier one capital – the safest form of assets that they hold.
RBS had a core tier one ratio of approximately 11% at the time of its interim results earlier this year.
Some RBS insiders questioned whether selling Citizens at current market valuations would achieve the FSA's objective of improving its capital position.
Analysts at Shore Capital said today that the bank "should consider selling Citizens if it receives an offer in excess of £6bn as this would…deliver a significant positive impact on the group capital base".
Mr Hester may also sanction a further reduction in the size of RBS's investment bank, particularly where operations do not meet their cost of capital, but this is likely to take place gradually, people close to the bank said.
The RBS chief has said repeatedly that he is willing to offload any part of RBS if it delivered value for investors.
RBS, which successfully floated its insurance arm, Direct Line Group, last week, suffered a fresh setback on Friday when Santander UK abandoned a £1.6bn deal to acquire 316 of its branches.
The FSA and RBS both declined to comment.