RBS's investment bank to shrink

The chancellor is today announcing a major strategy change at Royal Bank of Scotland, namely a big reduction in the size and scope of its investment bank.

George Osborne is in the process of telling MPs that he supports plans by RBS to shrink its investment bank into a business much more focused on UK companies.

According to a Treasury source, the reconstruction of RBS's investment bank will take it back broadly to the kind of investment bank that was owned by NatWest, the big British bank bought by RBS a decade ago.

There is expected to be a significant retreat from North America, where the bank acquired a big presence when Sir Fred Goodwin was chief executive.

Mr Osborne has to be careful how he words his support for these cuts to RBS's Global Banking and Markets division, because he does not want to become what's known as a "shadow director" of the bank; as a shadow director, he would become personally liable for its decisions.

But the state owns 84% of RBS, acquired during the 2008-9 bailout of the bank. So it can be taken for granted that what the chancellor says in parliament about the bank's future direction will happen.

'Biggest ever bank bailout'

In the great rescue of RBS, which is described by the Treasury as "the world's biggest ever bank bailout" (in its reponse today to the reform recommendations of the Independent Commission on Banking), British taxpayers injected £45.5bn of new capital into RBS.

At today's share price, that £45.5bn investment has fallen in value by a painful £27bn.

Not all of the colossal losses at RBS were generated by the investment bank. But during the crash, the investment bank did incur several billion pounds of losses, some stemming from exposure to investments linked to US subprime.

The view of the Treasury is that an organisation like RBS that is largely nationalised should not be placing the kind of bets routinely made by investment banks, given that the vast bulk of the rewards from these bets when they go right accrue to investment bankers in the form of substantial bonuses - whereas losses (last time at least) fall on taxpayers.

This reorganisation of RBS into a business much more focussed on retail banking - and where its investment bank will serve British companies to which it has strong ties - should also mean that it will be less difficult and costly for RBS to put in place the new protective ring-fence around retail banks, which the chancellor is today promising to impose.

The point of this reform, and of the associated transfer to investors and lenders of the potential costs of bank failure, is to insulate taxpayers and the economy from the costs of future banking crises.