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LONDON (Reuters) - Royal Bank of Scotland (RBS.L) should consider the future of its U.S. business Citizens and reduce the size of its investment bank, the agency in charge of Britain's stake in the bank said.
"I would confirm that among the strategic issues we have discussed with management are the U.S. operations and the investment bank," said Jim O'Neil, chief executive of UK Financial Investments which oversees the government's 82 percent stake in RBS.
"The investment bank shape and size ultimately should be smaller than it is today," O'Neil told the Parliamentary Commission on Banking Standards on Tuesday.
The future of Citizens has been under scrutiny as it does not fit with RBS's narrowed focus on its home market, although Chief Executive Stephen Hester was expected to try to delay any sale until a turnaround of the business was more advanced.
Citizens and its subsidiaries, which operate more than 1,500 branches across 12 states and employ 20,900 staff, could fetch more than 9 billion pounds ($14 billion), analysts have estimated.
Hester did not rule out a sale when asked about Citizens last month, saying his focus was on improving its profitability.
O'Neil also said RBS (RBS.L) and Lloyds Banking Group (LLOY.L) - 40 percent government-owned - should both complete restructuring programs by the end of next year, paving the way for the government to start selling its stakes in the banks.
RBS chairman Philip Hampton said last week the bank was preparing for the government to start selling its shares in 2014 and was laying the groundwork for a possible share sale to both institutions and to individual investors.
Earlier this year, Britain held talks with Abu Dhabi about a possible investment in RBS. O'Neil said UKFI was open to proposals that offered value for money to the taxpayer but considered a sale to institutions to be more likely.
"It is most likely some kind of market transaction but we do not rule anything out. It might be institutions or it might be a very broad offering including retail. We cannot rule anything out that offers value for money to the taxpayer," he said.
Taxpayers are sitting on a paper loss of over 20 billion pounds on RBS after the government pumped 45 billion into the bank to keep it afloat on 2008.
RBS last week withdrew from a government plan that insured its riskiest loans, clearing an important hurdle on the path towards freeing itself from state ownership.
The bank's immediate future is clouded by an ongoing probe into manipulation of Libor and other interest rates.
O'Neil said UKFI was informed of the investigation by RBS earlier this year. Some analysts have said RBS could face a worse punishment than Barclays (BARC.L).
Reporting by Matt Scuffham; Additional reporting by Steve Slater; Editing by Dan Lalor