By Matt Scuffham and David Milliken
LONDON (Reuters) - Britain is ready to start selling its shares in Lloyds Banking Group <LLOY.L> and will examine whether to break up Royal Bank of Scotland <RBS.L>, Finance Minister George Osborne said, admitting the re-privatization of RBS remains a long way off.
The government is keen to show Britain's part-nationalized banks are recovering from the 2008 financial crisis and a profitable sale of part of its 39 percent stake in Lloyds would allow it to claim at least partial success ahead of the next election in 2015.
Osborne's decision to investigate hiving off RBS's weak assets, largely soured property loans in Ireland and Britain, into a so-called "bad bank" comes after a parliamentary commission he appointed recommended such an analysis earlier on Wednesday.
The finance minister had previously dismissed breaking up RBS as too costly and disruptive and in his annual address to financiers in the City of London he said such a split would only happen if it was in the best interests of taxpayers and didn't require them to put any additional capital into the bank.
"We will establish a Bad Bank if it meets our three objectives: if it supports the British economy; if it's in the interests of taxpayers - and if it accelerates the return to private ownership," he said.
The review, which will be completed in the autumn, marks another jolt for Royal Bank of Scotland, whose chief executive Stephen Hester was ousted last week with the green light from Osborne.
RBS's chairman said he welcomed the government's plans.
"Proposals that could speed RBS's privatization while allowing us to support our customers deserve thorough consideration. Ultimately any change to our strategy would need to be in the interests of all shareholders," Philip Hampton said in a statement.
The government pumped a combined 66 billion pounds ($103 billion) into the banks to keep them afloat during the 2008 financial crisis leaving it with an 81 percent shareholding in RBS and 39 percent of Lloyds.
Osborne said the government was willing to discuss how RBS can buy its way out of a dividend access share, which gives the state priority over dividends and has been seen as a major obstacle to privatization, once the review into the bank's future had concluded.
THE WORK OF A GENERATION
Osborne has come under pressure from a range of people, including the outgoing governor of the Bank of England, Mervyn King, as well as party colleague and former finance minister Nigel Lawson, to consider splitting up RBS.
Speaking just after Osborne at the City of London's Mansion House, King welcomed Osborne's plans but said more needed to be done to restore the banking system to full health.
On Thursday the BoE's regulatory arm will publish details of how much new capital Britain's banks need to raise, with media reports suggesting that Lloyds, RBS and Barclays <BARC.L> will bear the brunt.
"There is clearly some way to go before we can claim to have a really well-capitalized banking system," King said, rejecting some banks' view that higher capital requirements are acting as a brake on their ability to support the economy.
A longer-term problem was the size of some British banks, which are still too large and complex to be allowed to collapse without causing financial chaos, King said.
"We must restore trust in our banking system," said King. "It is not in our national interest to have banks that are too big to fail, too big to jail, or simply too big. Solving these problems is the work of a generation."
King steps down at the end of this month to be replaced by former Canadian central bank chief Mark Carney. The government said on Wednesday the Queen had made King a Lord for his service to the country.
While the government is sitting on a paper loss of nearly 10 billion pounds on its stake in RBS, shares in Lloyds are already trading above the government's break-even price of 61.2 pence, having been the top performer in the FTSE-100 <.FTSE> last year.
Osborne said the government was actively considering options for selling shares in Lloyds. He said the first sale would likely be to institutions, such as pension funds, but it would consider all options for subsequent sales, including selling shares to the public.
A spokesman for Lloyds said the plan was a matter for the government and declined further comment.
($1 = 0.6386 British pounds)
(Reporting by Matt Scuffham; Editing by Carmel Crimmins and Giles Elgood)