RBS places troublesome assets worth £38bn in internal 'bad bank'

RBS chief Ross McEwan and chancellor George Osborne at the bank's London headquarters

Royal Bank of Scotland warned on Friday that it was on course for a substantial loss this year, dashing any remaining hopes of a return to the private sector until after the 2015 election.

Announcing that £38bn of troublesome loans would be ringfenced within the bank, the new chief executive Ross McEwan heralded a "resetting" of the often fraught relationship with the Treasury – owner of 81% of the shares – and the Bank of England, which regulates the bank and is poised to impose tougher rules on capital.

McEwan who took the helm only a month ago after Stephen Hester was ousted in the summer, said he wanted to end the "weariness" and "defensiveness" that had crept into RBS. He is embarking on a review of all the bank's operations – including its troublesome Ulster operations in Ireland and the already-scaled back investment bank – which will be announced in February. He will accelerate the sale of the US arm, Citizens.

"The bar for RBS is higher than for any other bank because we got saved by the UK government," said McEwan. A highly critical report into its lending to small business found it turning away three out of every four applications for business loans and acting too aggressively towards customers in difficulty.

Unions feared a new wave of job cuts on top of 30,000 already axed since the 2008 bailout. Dominic Hook, Unite national officer, said: "Management claim that customer service is a priority for the bank and its reputation depends on it but RBS has cut staff numbers to the bone."

RBS shares were the second biggest fallers in the FTSE 100, down 7.5% at 340p – well below the 500p average price the taxpayer spent £45bn buying them for – after the bank reported a third-quarter loss of more than £600m.

Demonstrating a thawing of relations with the new boss, ChancellorGeorge Osborne was at the London office of RBS for the announcement of the result of the review he had commissioned into whether the bank should be split up.

The study by financial advisers Rothschild, estimated to have cost £9m, stepped back from a full break-up and creation of a "bad bank" suggested by senior figures such as former chancellor, Lord Lawson and former Bank of England governor Lord King.

Instead, about £38bn of troublesome loans – including £9bn from Ulster Bank – will be placed into a new non-core division to be known as the capital resolution division, which the bank aims to wind down in three years. This will mean writing off up to £4.5bn of problem loans in the next quarter – driving the bank to a "substantial loss" for the full year. But some £11bn of capital should be released as a result.

McEwan insisted the government had not forced RBS into the new-look non-core bank, saying it had to listen major shareholders. "If you were a hedge fund and had 81% of the business you'd want to be having good conversations," he said.

Commissioned following a recommendation by the parliamentary commission on banking , the review concluded the "effort, risk and expense involved in the creation of an external bad bank is not justified".A 150 page document published by the Treasury said creating bad bank would "do more harm than good".

Labour MP Pat McFadden, who sat on the commission, said the outcome "simply changes the name plate on what was already happening". Lord McFall, also on the commission, said on Twitter it was the "status quo w[ith] frills".

But Osborne said the bank was now set on a "new direction", to focus on the UK and small business lending and become a bank that would be "batting for Britain". A sale of the government's stake was unlikely to happen before the May 2015 election, Osborne said.

Sir Philip Hampton, RBS chairman who had previously indicated a sale could start next year, said that since its bailout RBS had pumped £15bn into Ulster bank, paid out more in compensation to customers and paid fees to the government which should be taken into account when assessing its share performance.

McEwan's aim is "to dispel any suggestions that RBS is travelling light on capital" at a time when the Bank of England is preparing to force all UK banks to hold more capital and more quickly than international regulations require. It is aiming for a 12% ratio in three years. The Treasury said the bank needed to "accommodate any additional headwinds which may adversely affect their capital resources, for example future costs of redress".

The bank took a fresh provision for payment protection insurance mis-selling of £250m – taking its total bill so far to £2.65bn, and admitted it was involved in new investigation into alleged manipulation of foreign exchange markets.

RBS is now in discussions about releasing the dividend access share that would have forced the bank to pay dividends – when it could afford them – to the government before its other shareholders.

An £8bn contingent capital facility which required the government to pump more money into the bank if its capital ratio fell is now being repaid a year early.