Should the Treasury keep 'bad' RBS?

The Treasury is not keen on breaking up RBS

The Parliamentary Commission on Banking Standards is deliberating on its final report, which - I am told - is unlikely to be published before June.

A tricky issue for it is how to respond to the recommendation from the Governor of the Bank of England that Royal Bank of Scotland should be cleaved in two, with the remaining toxic assets - and they are pretty stinky - retained in the public sector, while "good" RBS is privatised.

As it happens, for all the criticism of RBS, it has done a pretty effective job of shrinking its non-core and poor assets from many hundreds of billions of pounds to several tens of billions of pounds.

But what remains is pretty horrible and hard to shift.

And the argument of the Governor of the Bank of England would be that - by cutting out these poisonous assets - RBS would be strengthened both financially and psychologically.

On the one hand, the ratio of capital to assets would be boosted very significantly in "good" RBS, because some loans and investments with very high risk weights (in the jargon) would have been detached.

And, perhaps more important, both those who work for RBS and those who lend to it would be more confident that some further downturn in economic conditions was not going to generate humungous additional losses.

So RBS might find it cheaper to borrow, and it might also have a greater appetite for risk when lending.

And the UK economy would therefore be a winner.

Stagnant pool

What's more, RBS's board would be pretty happy if the bank was cleaned up in this way, I understand, for a pretty obvious reason.

Clean RBS, minus the toxic assets, would be much easier to privatise than the existing RBS.

So why hasn't it happened? And why is the Treasury still very resistant to the idea of breaking up RBS in this way (which it is)?

Well, as I understand it, the Treasury looked at a break up of this sort just a couple of years ago.

And the primary reason it did not want to go ahead is that it would have to find a way to fund these assets, these loans and investments: the amount owed to RBS in this stagnant pool of assets is matched by funds RBS has borrowed; so the government would have to borrow to cover the written down value of the bad banks' assets.

The amount of new gilts it would have had to issue a couple of years ago to set up the bad bank was prohibitively great. But by the end of this year, the funding requirement would be "just" £40bn.

However that is a large amount of additional borrowing for a government struggling to reduce its annual deficit, or borrowing needs, from an unsustainably large £120bn.

And there might be an unfortunate precedent for the Treasury if it were prepared to borrow £40bn to sanitise RBS, because its critics might question why it won't do the same to finance substantial new infrastructure projects.

But if the Treasury is wary of breaking up RBS, the Banking Standards Commission does not look to me to be keen to drop it altogether as an idea,

If it were to ask the Treasury to properly evaluate the costs and benefits of breaking up RBS, and publish such an evaluation, it would be difficult to see how the Chancellor could refuse.