Royal Bank of Scotland (RBS) and Lloyds Banking Group are to sell off branches in another major shake-up of the UK banking industry.

The sales have been demanded by the European Commission to safeguard competition concerns after the two were bailed out by the UK government.

RBS will sell 318 branches, while Lloyds will dispose of more than 600 branches over the next four years.

Lloyds also confirmed it would stay out of a government-run insurance scheme.

Lloyds, which is 43.5%-owned by the government, will instead raise £21bn, including a £13.5bn rights issue and a £7.5bn debt swap.

But it will have to pay the UK government £2.5bn to avoid joining the Government Asset Protection Scheme (GAPS), which provides state insurance for past toxic loans.

The payment is to cover the “implicit protection” provided by the government since it first offered to insure Lloyds’ book in February.

RBS, meanwhile, has confirmed it will join the scheme on revised – and more expensive – terms, the Treasury said.

“I believe what we have here is a better deal for the taxpayer,” Chancellor Alistair Darling told the BBC.

“It is better in the long run to get private money because at the end of the day, the government does not want to be in the business of running banks,” he added.

The BBC’s business editor Robert Peston suggested the Treasury has now effectively become the biggest hedge fund in the UK.

‘New entrants’

In addition to the sales of RBS branches in England and Wales – originally Williams & Glyn’s, RBS will sell its NatWest brand in Scotland, RBS Insurance and Global Merchant Services, its card payment business.

The total disposal will be 318 branches in the UK, or 14% of the RBS retail network.

“I believe today marks a key milestone in the radical restructuring we are undertaking to bring RBS back to stand-alone strength,” RBS chief executive Stephen Hester said.

RBS said the moves would cut its UK market share by two percentage points in retail banking.

It will also sell its stake in commodities trader RBS Sempra Commodities.

Lloyds will sell at least 600 branches, or about 4.6% of the total market of UK current accounts.

That includes the TSB brand in England, Wales and Scotland and mortgage broker Cheltenham & Gloucester, as well as the Intelligent Finance online business.

Lloyds says the businesses that it will have to sell off account for about £30bn of customer deposits and £70bn of lending, generating income of £1.4bn in the year to December 2008.

Mr Peston said the “forced fragmentation” of UK banks was a priority of outgoing European Competition Commissioner Neelie Kroes.

But Mr Darling insisted the government wanted the break up to happen.

“We were very clear with the Commission that we didn’t want to see the banks move pieces around a board,” he said.

“I would like to see, perhaps three new entrants to the High Street.”

Names like German insurance giant Allianz, Generali and Zurich are being mentioned as potential acquirers for the branches sold by RBS and Lloyds, said Douglas Fraser, BBC Scotland’s business editor.

Asset insurance

Unlike Lloyds, RBS will join GAPS and have £282bn of its assets insured by the taxpayer.

That is less than £325bn of toxic assets first proposed in February, according to the Treasury.

As a result, the UK government’s stake in the troubled banking giant will rise to 84%, though the Treasury said its ordinary shareholding will not exceed 75%.

Under GAPS, the government insures – for a price – some of the expected future losses on past investments made by our banks.

If those losses crystallised, some of them would in effect be transferred to the taxpayer.

However, if they did not, the taxpayer might make a profit on the premiums that the government will have charged.

RBS will pay the UK government £700m a year to be in the scheme, and £2.5bn to exit the scheme if and when that happens.

Both RBS and Lloyds have agreed to increase lending to businesses and property owners by a total of £39bn.

They have also agreed not to pay any bonuses to staff earning more than £39,000 for their performance in 2009.