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Another Reason to Sell RBS

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LONDON -- You might think that loyal Royal Bank of Scotland (LSE: RBS.L  ) (NYSE: RBS  ) shareholders have suffered enough. But on top of a 1.5 billion pound loss in the first half of the year, the government is now threatening to nationalize the bank.

At least that's what some would have us believe, prompted by a report Thursday in the Financial Times. It looked to me like a shot across RBS' bow. But it's an equally worrying development, if the government's agenda is to press the bank to lend greater amounts in the face of the U.K.'s deteriorating economy instead of concentrating on off-loading the shares from taxpayers' hands as soon as possible.

RBS' management has been playing the card of "we can't do what you tell us; we have a responsibility to our minority investors." The government's retort is that if RBS does not play ball, it will be taken over by the taxpayer and run for the benefit of the country.

That suggestion has been ridiculed by financial analysts. If RBS' management walked out the door en masse, the civil service would be poorly placed to run a full commercial bank. While there may be an argument for the U.K. to have a state development bank that provides soft loans for small and medium enterprises, the best way to create it would not be to start with RBS.

So the nationalization threat is just talk. But the really worrying aspect for private investors is the tensions it reveals between the government and RBS management. Indeed, the parties have barely finished rowing over CEO Stephen Hester's remuneration -- intense political pressure was brought to bear before he agreed to forego his 2011 bonus.

Now it looks as if some members of the cabinet are keener to use RBS as a tool of economic policy than to achieve its early privatization. Suspicion points to business secretary Vince Cable. He wrote to the prime minister in February calling for RBS to be broken up to create a British Business Bank with a mandate to expand business lending rapidly.

Prime Minister David Cameron dismissed the idea saying that "what mattered most of all" was to get RBS back to health in order to sell the government's stake. We have yet to hear that repeated this time around, and for good reason. Chairman Sir Philip Hampton told the annual general meeting in May that investors had no chance of recouping pre-financial-crisis losses in their lifetime.

Reportedly chancellor George Osborne is the obstacle to serious work being done on a nationalization plan. But Osborne is not above interfering in RBS' strategy: In February he called for it to scale back its investment bank.

The government is now on its third attempt at prodding the banks to increase business lending. Project Merlin, which set lending targets, was discontinued after a year of operation. The National Loan Guarantee Scheme had barely got off the ground before it began being wound down.

Now the Treasury has unveiled details of the "funding for lending" scheme that will lower banks' borrowing rates if they increase their lending. Banks will receive 1 pound of cheap funding from the Bank of England for every 20 pounds of loans to companies and households. Barclays state-owned Lloyds Banking are expected to join the scheme.

But significantly, HSBC has declined to participate. It says it funds its loans from customer deposits. That's the way the banks always used to work, and it is a sign of HSBC's superior quality that it is still able to do so. It's a sorry state of affairs when the government has to artificially support the banking sector.

If you are generally wary of banks, then you are in good company. One savvy investor who sold out of the sector before the credit crunch and has since steered clear is Invesco Perpetual's Neil Woodford. You can learn more about his investment style and approach in this Motley Fool report: "8 Shares Held By Britain's Super Investor." It's free and will be delivered to your inbox immediately by clicking here.

If you didn't have Woodford's foresight and are sitting on RBS shares bought at a much higher price than today's 229 pence, it may be time to think about cutting your losses.

Oils, pharmaceuticals, banks, telecoms -- just where should you invest today? "Top Sectors for 2012" is the Motley Fool's latest guide to help Britain invest. Better. The report is free.

Further investment ideas:

Tony owns shares in HSBC but does not own any other shares mentioned in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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