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Why Royal Bank of Scotland Group plc Looks A Better Bet Than Lloyds Banking Group PLC

Both Royal Bank of Scotland (LSE: RBS)(NYSE: RBS.US) and Lloyds (LSE: LLOY)(NYSE: LYG.US) have shown that they are capable of big rises — and falls. This is my analysis of the investment case today.

Lloyds

With a 33% stake, the UK government is a minority shareholder in Lloyds. This means that politicians cannot force changes at the bank by themselves. This is a source of some relief to the markets and likely goes some way to explaining why the bank’s share price recovery has been stronger than RBS’s.

Shares in Lloyds are up 56% so far in 2013. However, in the last three months, Lloyds’ share price is only slightly ahead. In that time, the FTSE 100 is up more than 2%. There are two likely reasons for this underperformance.

The first is that the UK government has been selling down its stake in Lloyds. On September 20th, UKFI (the body that the government uses to manage its stake in the bailed-out financials) announced the sale of 5bn shares in Lloyds at an average price of 75p. The prospect of further sales in 2014 reduces the incentive for investors to bid the price up today.

My second concern is the claim that Lloyds staff may have attempted to rig global currency markets. If proven, this will likely result in large fines.

Royal Bank of Scotland

The UK taypayer owns 82% of RBS. As a result, the government feels that it can throw its weight around. This is holding back the bank’s share price.

Three weeks ago, shares in RBS stood at a two-year high. Since then, the shares have fallen hard as RBS has been forced to implement expensive changes by its majority shareholder.

Add to this the revelations that RBS staff may have been involved with attempts to rig foreign exchange prices and you have the recipe for a substantial share price fall.

RBS’ last results revealed an operating profit for the third quarter of £438m. Even with the new costs that are being forced upon it, RBS shares still trade at a significant discount to book value. It is this gap that, in my opinion, gives RBS the edge over Lloyds.

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> David owns shares in Royal Bank of Scotland but none of the other companies mentioned.