U.K. to Break Up Royal Bank of Scotland, Lloyds

Unlike government officials in the U.S., the Brits aren’t afraid of breaking up banking companies regarded as too big to fail.

Under pressure from the U.K.’s Financial Services Authority and the European Commission, Royal Bank of Scotland and Lloyds Banking Group said today that each will sell portions of their respective branch networks. RBS, which is partly nationalized, also will unload its insurance division, part of a deal with the government for the company to secure an additional $41.6 billion in aid.

While noting that the slimmed down RBS will remain strong, chief executive Stephen Hester made clear the company is divesting the units unwillingly. And in a statement he conceded that, well, RBS needs the money:

The agreement in principle reached with the [European Commission] is clearly more material for the structure of our group than we had hoped, increasing risk to both execution of the plan and earnings dilution. But this is still an acceptable result for RBS. Whilst the required divestitures include businesses which were part of our plans going forward, the group’s essential strengths remain intact, and the divestiture proceeds will help our future capital position. . . .

Lloyds, which is also partly state-owned after receiving billions of pounds in a government bailout, expects to sell roughly 600 branches, along with other assets, under an agreement with regulators.

RBS will raise the public funding by selling more shares to the British government. Lloyds is taking a different route. It plans to raise a whopping $67 billion in what be the biggest private rights offering ever in the U.K. That would allow the company to boost its capital without the government having to expand its roughly 40 percent stake in Lloyds.

There are meaningful differences between the British and American financial industries. But one commonality is that both orbit around mega-banks whose sheer size poses unmanageable economic risks, as we’ve learned the hard way. U.K. officials, notably Bank of England head Mervyn King, clearly reject the propaganda that breaking up these companies would hobble the British economy. As Chancellor of the Exchequer Alistair Darling recently put it:

If we don’t have more competition we’re going to end up with perhaps half a dozen big providers, and that really would represent quite a major reduction in choice and that just would not be acceptable. What you really want to do is to have quite a substantial divestment [by RBS and Lloyds].

That’s a lesson U.S. banking regulators and lawmakers would do well to learn.