Royal Bank of Scotland (RBS) is to create an internal "bad bank" to fence off its riskiest assets, part of a raft of measures designed to heal its relationship with the British government and speed up its eventual privatisation.

Britain is keen to offload its stakes in RBS and state-backed rival Lloyds Banking Group as soon as possible, having pumped a combined £66 billion ($106 billion ) into the banks to keep them afloat in the 2008 financial crisis.

"I think it does make it easier to sell off the bank and get our money back," Finance Minister George Osborne said yesterday, adding that a sell-off was unlikely to begin before the next election in 2015.

Britain began selling shares in Lloyds at a profit earlier this year, but a sale of its 81 per cent stake in RBS is much further off, with taxpayers still sitting on a paper loss of nearly £14 billion at current prices.

Bankers and political sources have said it could take three to five years to offload the government's stake.

"The tests for these changes at RBS are whether they see the taxpayer ultimately get its money back and whether they actually boost business lending and radically transform this bank to put an end to business as usual," said Ed Balls, the opposition Labour Party's finance spokesman.

The government stopped short of ordering a formal break-up of the bank, which had been advocated by former Bank of England governor Mervyn King, and by Nigel Lawson, a former UK finance minister and a member of the influential Parliamentary Commission on Banking Standards.

They had argued that it would leave the bank better placed to lend and support the UK economy, but opponents said it would be too expensive and complicated.

The government said the restructuring, along with other measures such as the speeding up of plans to sell its US retail bank, Citizens, would enable it to focus on lending to British households and businesses.

RBS said it would put £38 billion ($61 billion) of loans into a new 'capital resolution division' next year, which would free up £10-11 billion of capital.

But critics said it was not much different to the bank's existing non-core asset run-down programme, which currently houses £45 billion of problem loans and was expected to still have £20 billion in 2016. About half of the assets to go into the 'bad bank' are currently held in that division.-Reuters