The European Commission's demand that Royal Bank of Scotland and Lloyds sell assets will be closely watched, writes MARK HENNESSY, London Editor

HUNDREDS OF bank branches throughout the UK, along with insurance businesses and credit card payment operations belonging to Royal Bank of Scotland (RBS) and Lloyds Banking Group will go under the hammer over the next four years.

The two banks did not want to sell. Chancellor of the exchequer Alistair Darling did not want to force them to do so. But European Competition Commissioner Neelie Kroes insisted. And she got her way.

The question that may exercise top executives in AIB and Bank of Ireland now is what attitude commissioner Kroes will take when finally she sits down to decide on their restructuring plans.

The two major banks hold more than half of all outstanding debt in Ireland, though competition at the retail end of the market is better than in many EU states. But the commission draws a distinction between market distortion and competition.

Bank of Ireland lodged its paperwork on September 30th. It is now dealing with follow-up queries and has not had “any clear indications” as to what the commission thinks of its application. AIB has until the end of this month to file.

The commission’s power is being seen elsewhere. Dutch bank ING last week said it would sell its ING Direct operations in the US, and pay the Dutch government extra fees to satisfy Brussels.

Typically, neither the British prime minister nor the chancellor gave the commissioner any of the credit for the sell-off order, implying instead that it had come on their initiative.

Back in July, the commission laid down a number of principles to govern the restructuring of banks left struggling by the credit crisis, including measures to limit “distortions of competition”.

“Distortions may come from prolonging the bank’s inadequate or excessively risky past behaviour and/or from maintaining its market presence to the detriment of competitors,” the Competition Directorate General said. Large state support “may require some adjustments including structural measures, such as divestitures” spread over a number of years, or “constraints on acquisitions or on aggressive pricing and marketing strategies funded by state aid”.

RBS chief executive Stephen Hester acknowledged the need to sell some of the bank’s branch network, but the forced sale of other businesses, including RBS Insurance “neither improve competition nor make our task of repaying the taxpayer easier”.

Essentially, the commissioner has decided RBS should be given a hiding to deter others from the kind of foolishness that the bank carried on with under the command of Fred Goodwin. Kroes has decided that RBS has to be made an example of for taking so many risks during the boom years that it now needs a mind-boggling amount of taxpayers’ support.

It will have to part with its Churchill and Direct Line insurance units that handle up to 17 million policies annually, though it should be able to get a decent price given that it has been given so long to get rid of them – assuming that matters do not take another turn for the worse.

The scale of the failure by the Financial Services Authority and regulators elsewhere is starkly illustrated by the FSA’s decision that both banks must, in future, hold nearly 10 per cent of “tier one” capital – four times what was required before the global crash.

The details of the RBS/Lloyds agreement with Brussels may hold other lessons for banks in Ireland, since both have agreed not to pay dividends on preference share, or B shares for two years “unless legally required to do so”.

The Irish Government invested €7 billion in preference share capital in both Bank of Ireland and AIB, with an 8 per cent coupon attaching, which could be converted into ordinary shares in the next five years at the original price. The British government, for its part, has committed itself to invest £25.5 billion in B shares with a 7 per cent coupon – which would have been worth £1.8 billion, or so a year to Her Majesty’s Treasury.

The restriction imposed by Brussels will affect pension fund and insurance company investments in the two banks, as the Association of British Bankers was quick to point out once the detail had been parsed and analysed.