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* Assets worth up to 120 bln stg could be hived off - source
* Much of Ulster Bank could land in 'bad bank' - source
* Complexity, expense, state aid rules seen as obstacles
* Treasury to review options with 'external support'
By Matt Scuffham
LONDON, June 20 (Reuters) - Britain would face big obstaclesto a break up of state-controlled Royal Bank of Scotland and such a step might not achieve its ultimate aim of boostinglending to the economy, analysts and investors said.
Britain's government has come under pressure to considersplitting the 82 percent state-owned bank partly becauseprospects for returning it to private ownership soon still seemremote five years on from its 45.5 billion pound ($71.25billion) rescue in the financial crisis.
The plan, backed by former British finance minister NigelLawson and outgoing Bank of England governor Mervyn King, hasgained support because it has taken longer for RBS to return tofinancial health than expected while lending to the economyacross British banks as whole remains sluggish.
But analysts and investors believe a break up would be acostly, complex and lengthy process that would not necessarilybenefit the economy or taxpayers.
"The decisions to seriously consider a break-up intogood/bad bank will further increase the uncertainty about thefuture shape of RBS, especially as the Chancellor (GeorgeOsborne) expects the bank to support core UK businesses," saidEspirito Santo analyst Shailesh Raikundlia.
One of RBS's ten biggest investors warned the move coulddamage the wider economy.
"RBS's record on new lending in the UK mortgage market isalready very strong," the investor said. "It is possible thatthe capital strain of a split could produce the reverse effectfrom that intended, that is it could actually cause less lendingto the UK economy."
Finance minister George Osborne has said the governmentwould investigate the case for hiving off RBS's toxic loans intoa "bad bank", leaving a "good bank" better placed to lend toBritish households and businesses. Osborne said any break-upwould not involve taxpayers putting in further funds.
Both Ireland and Spain have gone down the "bad bank" routeto tackle their banks' bad assets.
COST AND COMPLEXITY
The Conservative-led coalition is considering hiving off RBSassets worth between 100 billion pounds and 120 billion pounds,according to one source familiar with the matter.
Ulster Bank, owned by RBS, could have its non-core assetsand commercial real estate assets moved into the bad bankfollowing a break up, along with some UK commercial real estateassets of RBS, the source said.
Osborne, himself, had previously rejected the idea, alsociting the cost and complexity involved. Critics have pointedout that it would cost billions of pounds just to buy out thebank's minority shareholders, which would have to happen beforethe break-up could take place.
In his annual speech to City of London financiers onWednesday, Osborne said, with hindsight, RBS should have beenbroken up five years ago. He stopped short of criticising hisLabour predecessor, Alistair Darling, who was in power at thetime, admitting he had not proposed such a move in opposition.
The Parliamentary Commission on Banking Standards, which wasset up by Osborne to review the industry, had called on theTreasury to produce a report on the pros and cons of a break-upby September, a recommendation the Chancellor has heeded.
Osborne said Britain would establish an RBS "bad bank" ifthe review concluded the move would support the British economy,be in the interests of taxpayers and accelerate the bank'sreturn to private ownership.
The review will be undertaken by the Treasury with externalsupport and will report back by the autumn. It is not yet clearwhether that support would come from individuals or a financialinstitution.
RBS has already undertaken a mammoth restructuring, overseenby outgoing Chief Executive Stephen Hester since its rescue,shedding some 900 billion pounds of non-core assets but it stillhas assets worth around 1.2 trillion pounds.
In contrast to RBS, the government has said it is ready tostart selling its holding in rival Lloyds, also bailedout in the crisis, allowing it to claim partial success inreturning the banks to health ahead of the next election in2015.
