Shares in RBS plunge as bank warns of tough years to come

Chief executive says it will take five years for bank to recover from bad debts

The chief executive of Royal Bank of Scotland yesterday gave a sobering assessment of the company's prospects over the next two years, warning that results would be "poor", as the bank reported a £7.5bn hit from bad debts.

Stephen Hester said provisions against bad loans were set to increase in the coming months and admitted the bank would probably have to call on taxpayers for yet more cash through the Government's asset guarantee scheme. RBS shares closed down 6.5p at 47p last night. The Government paid £20.5bn for a 70 per cent stake at an average of 50.5p per share.

"Even if the economy starts to turn up the headwinds will be formidable," Mr Hester warned. "The green shoots are short in duration and you need to be cautious about interpreting them. Even if growth returns, unemployment will rise for some time afterwards and [loan] impairments will rise. It will take five years for this bank to be in the state that we want it to be in."

His statement came in stark contrast to that earlier this week from Lloyds TSB, which is 43 per cent owned by the state, and whose chief executive Eric Daniels said he believed its bad debts had peaked.

RBS surprised some City analysts by reporting a pre-tax profit of £15m for the first six months of the year in its 204-page results statement. But that was largely due to one-off accounting quirks – its operating profit actually showed a loss of £3.3bn.

The company's investment banking division has benefited from its powerful position in the bond markets, which have seen unusually high levels of activity as governments have borrowed heavily to fund stimulus packages.

This helped to cushion RBS against the heavy losses it made on bad loans but is not likely to prove sustainable. However, it will likely see bumper payouts for staff at the investment bank, some of whom are on guaranteed bonuses. Mr Hester defended this, saying: "People don't always feel secure if we want them to come here. There are people who might be leaving who we need to retain. For the taxpayer to make a profit we need to hire the best people." He said the rate of attrition in the bank's top staff had doubled and hiring was "proving tough" and no guarantees were offered for more than a year.

Mr Hester also said rising levels of bad loans made the asset guarantee scheme essential if RBS was to pass stress tests demanded by the Financial Services Authority. He has split the bank into a core business, where operating profits were up by a third at £6.2bn, and a non-core "bad" business filled with unstable assets and operations slated for disposal, which lost £9.6bn.

Up to £316bn of assets are likely to be covered by the guarantee scheme, but Mr Hester said there was still haggling to be done over the terms, and that EU approval would be needed. European regulators are also concerned about the bank's dominance in the small business market.

Despite this, Mr Hester insisted RBS was "open for business" and had money to lend to small firms. "If you know of a credit-worthy small company that needs money, send them to us," he said. "We have the money to lend."

Although RBS had refused loans to 30,000 businesses in the first six months of the year, that accounted for only 15 per cent of the total who applied, he insisted.

Despite the downbeat tone of the announcement, Mr Hester said he remained optimistic about the future of RBS and confident that the bank could be put back on its feet with a profit for the taxpayer.

The bank also unveiled Bruce Van Saun, a US banker, as its new chief finance officer. He will play a key role in its future and is likely to be offered a similar pay package to Mr Hester, who could earn up to £10m if he succeeds in returning the business to proftability and its share price rises.