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The Risks Of Investing In Royal Bank of Scotland Plc

Today I am highlighting what you need to know before investing in Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US).

Citizens Bank needs plenty of work

As part of its ongoing bid to strip out non-core and underperforming assets, Royal Bank of Scotland’s Citizens Bank operations in the US filed for flotation back in May. Initially the British bank plans to test the water by divesting between 20% and 25% of its holding in its North RBSAmerican arm by the end of this year, with full exit is pencilled in by 2016.

However, Royal Bank of Scotland will be required to undertake significant work at Citizens in order to get it back in decent working order and prompt full divestment, a situation which could take further time and effort should financial markets — and the still-fragile banking sector — take another downturn.

Indeed, the bank failed Federal Reserve stress tests back in March identified ‘deficiencies in RBS Citizens’ practices for estimating revenue and losses under a stress scenario and for ensuring the appropriateness of loss estimates across business lines given a specific stress scenario.’

Capital problems continue to crimp appeal

The sale of its North American entity is a critical part of Royal Bank of Scotland’s plan to build up its frankly underwhelming capital situation. Under European Union Basel III laws, the group’s fully-loaded Common Equity Tier 1 (CET1) ratio rang in at a shocking 9.4% as of the end of March, falling short of most of its sector peers and casting fears of further stress-test woes.

Although the company’s expense-reduction programme has achieved a great deal so far — costs dropped an additional 6% during the first quarter, to £3.2bn — revenues continue to decline as a result of arguably over-zealous asset stripping and poor performance at its core operations.

Indeed, group turnover slipped to £19.4bn last year, a huge departure from revenues of £32.6bn in 2010. And with revenue slippage continuing to outpace cost reductions, broker Investec expects Royal Bank of Scotland to report a further meaty fall to £17.8bn this year alone. Against this backdrop it is difficult to envisage the bank building its capital reserves near the required standard any time soon.

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> Royston does not own shares in Royal Bank of Scotland.