* Once-vast trading arm now makes just 1% return
* Investors, following Barclays activist, call for cuts
* RBS executive hints at action within months
* Rose takes on CEO role on Nov.1
By Sinead Cruise, Simon Jessop and Lawrence White
LONDON, Oct 8 (Reuters) - With weeks to go until Alison Rose
takes over as CEO of Royal Bank of Scotland,
shareholders are demanding a shake-up of the state-backed
lender, with cuts to its minnow investment bank topping their
agenda.
Rose's predecessor Ross McEwan said NatWest Markets was
worth keeping for its ability to supply foreign exchange,
financing and hedging to the bank's corporate clients but with
profits dwindling, investors say it is ripe for cuts.
RBS's investment bank once spanned the globe with assets
greater than Britain's GDP, but it also made catastrophic market
bets that led to a 45 billion pound ($55 billion) taxpayer
bailout during the 2007-2008 financial crisis.
Its business is now largely confined to bond trading and
earns around a 1% return on equity.
The debate over RBS's investment bank comes at a time when
rival Barclays faces pressure from activist investor
Edward Bramson to scale back its own trading business.
Five investors told Reuters that Rose should consider
shrinking NatWest Markets further as part of her bigger vision
for RBS, which should also include detailed plans to tackle the
threat from digital banks like Revolut.
"The big thing for me is they should look again at whether
it is really worth persisting with NatWest Markets at this
scale," said a top-10 investor at the bank who said he knows
other shareholders who feel the same way.
NatWest Markets tied up around 35 billion pounds or 18.5% of
the bank's assets while contributing just 11% of profits in the
first half of the year, said Barrington Pitt-Miller, portfolio
manager at Janus Henderson Investors, which has a small holding
in the bank's shares.
Its 1% return on equity in the first half is below the
bank's cost of capital, and with financial markets torpid in
Europe and client trading subdued, there is little chance of
squeezing out more profits.
"For a shareholder, purely staring at balance sheet
intensity and returns, it is optically a poor business,"
Pitt-Miller said.
The difference now versus previous calls to scale back the
investment bank is that RBS has sufficient capital buffers to
absorb the losses crystallised by cutting it back, he said.
Describing NatWest Markets as one of RBS's two "problem
children", together with Ulster Bank, a second major shareholder
said Rose needed to decide if it was possible to improve NatWest
Markets' returns "in a meaningful way ... inside the next 3-5
years".
"These consume 22% and 8% of the group's capital and
basically make no money," the shareholder said.
" are clearly doing okay at taking costs out but the
revenue environment is tough and volatile. We know how hard
Barclays struggles to get a decent return out of their
investment bank, and that is clearly a better business than
NatWest Markets," the first top-10 investor said.
FUTURE IN BALANCE
Senior RBS executives agree decisions on the future for
NatWest Markets will likely be taken in the coming months, with
Rose broadly expected to lay out her strategy for the bank as a
whole when full-year results are published in February.
The business is in the third year of a four-year turnaround,
Chief Financial Officer Katie Murray told investors at a
conference in September, and at the end of this restructuring
its return on equity will be between 5-6%.
"It's not the endgame for where NatWest Markets will need to
be," Murray said, while pointing out the value of the investment
bank to business clients and the importance of continuity of
service.
"We'll talk more and see over the coming months what the
next stage looks like for NatWest Markets."
($1 = 0.8192 pounds)
(Editing by Jane Merriman)