By Matt Scuffham
LONDON (Reuters) - Britain should hand most of its shares in Royal Bank of Scotland <RBS.L> and Lloyds Banking Group <LLOY.L> to the public, an influential think tank said, in what would be the country's biggest ever privatization.
The government, which pumped a combined 66 billion pounds ($102 billion) into the banks to keep them afloat during the 2008 financial crisis, wants to remove them from state control before the next parliamentary election in 2015.
Prime Minister David Cameron last month said he was "open to all ideas" for returning the banks to private ownership, an apparent shift in government thinking.
The Finance Ministry and UK Financial Investments (UKFI), which manages the government's shareholdings, have been expected to favor selling the shares in blocks to financial institutions, such as pension funds.
Think tank Policy Exchange said the government should sell a minority of the shares to institutions and hand the rest to the public via a mass distribution that could give individuals shares worth up to 1,650 pounds.
"We urge the Chancellor to take this method and apply it to both RBS and Lloyds giving the taxpayer an opportunity to profit from both and get the banks back into the private sector, where they belong," Policy Exchange said in a report on Monday, referring to finance minister George Osborne.
Lloyds is currently valued at 44 billion pounds, while RBS is worth around 19 billion. The sale of both banks would dwarf that of Britain's Royal Mail which, with a value of 2-3 billion pounds, is expected to become the country's biggest privatization for two decades later this year.
Policy Exchange is known to have the ear of senior government figures, adding weight to the chances of its proposal being given serious consideration. Osborne hired Neil O'Brien, a former director of the Policy Exchange, as a special adviser last year.
Osborne could address the issue in his annual Mansion House speech to financiers on June 19. He is also waiting for the publication later in June of a report from the Parliamentary Commission on Banking Standards, before he decides on what to do with the RBS and Lloyds shares.
Policy Exchange's proposal would enable 48 million taxpayers to apply for shares at no cost and with no risk attached, the think tank said. A 'floor price' would be set and taxpayers would make a profit on any rise in the shares above that level.
The Policy Exchange report didn't indicate what the floor price for each bank should be.
But, for example, the government could set it at 400 pence on RBS shares, and, if a taxpayer takes the shares and later sells them at 500p, they would get 100p per share and the Treasury would automatically get 400p back.
Taxpayers would not lose money as the shares would be returned to government ownership after ten years should they not rise above the floor price.
The think tank estimates only 20 to 30 million people would apply for the shares with many thinking it would require too much time and effort, despite applicants only needing to supply their name, address and national insurance number.
Taxpayers would receive shares worth between 1,100 pounds and 1,650 pounds depending on how many people take up the offer.
The government holds an 81 percent stake in RBS and 39 percent in Lloyds. Around 70 percent of the shares, currently worth 48 billion pounds, would be given to taxpayers under the proposal.
Policy Exchange said the option of selling all the shares to institutions would take years to complete. The think tank said it had spoken to institutions who had indicated the government would not be able to sell shares worth more than 5 billion pounds at a time and would have to wait for a year between sales, so as to avoid flooding the market.
A mass share distribution, by contrast, would enable both RBS and Lloyds to be fully nationalized in 2014.
The report, written by James Barty, former head of global equity strategy at Deutsche Bank, dismissed the idea of giving away shares to the public without the government claw-back, saying that would increase national debt by around 50 billion pounds.
Shares in Lloyds are currently trading marginally above the price which the government regards as break-even. However, the government is sitting on a loss of 9 billion pounds on its investment in RBS at current prices.
($1 = 0.6497 British pounds)
(Additional reporting by William James and Steve Slater; Editing by Erica Billingham)