Chancellor George Osborne must face up to taxpayer losses in Royal Bank of Scotland and accelerate plans to return the bank to the private sector, Bank of England Governor Sir Mervyn King has said.
The central Bank boss told MPs the Government had failed to take decisive action to overhaul RBS and needed to complete a radical restructure of the bank to create a healthy lender within a year.
He said RBS was holding the wider economy back, but added it was "not beyond the wit of man" to split RBS into a 'good' and 'bad' bank to ensure the cleaned-up group could support lending and boost economic recovery efforts.
"The lessons of history is that we should face up to it - it's worth less than we thought and we should accept that and get back to finding a way to create a new RBS that could be a major lender to the UK economy," he said.
Sir Mervyn's comments will come as a blow after RBS boss Stephen Hester last week insisted the bank's return to the private sector was on track and could be completed within two years. In a hearing with the Parliamentary Commission on Banking Standards, Sir Mervyn said plans should go further than those being led by Mr Hester to reduce RBS's balance sheet and signalled the Government should take charge to get the bank in a fit state "sooner rather than later".
He said it was "nonsense" that the Government could run the bank at an arm's length, given that it is 81% owned by the state.
"Time has passed and aside from reducing the balance sheet, nothing has been achieved - we haven't managed to get it into the private sector," said Sir Mervyn. "It would be much better to accept that it should have been a temporary period only, and the longer this goes on, the more difficult it becomes."
Sir Mervyn confirmed he had discussed his view on RBS with Mr Osborne, but the Chancellor recently told the commission he believes there are "very considerable obstacles" to splitting RBS in two and backs current plans to instead shrink its balance sheet and focus its activities on the UK.
RBS last week claimed improvements in the core bank would see it return to financial health next year as it reported underlying group operating profits nearly doubling to £3.5 billion in 2012 from £1.8 billion in 2011. But bottom-line figures revealed the fifth year of losses since its £45.5 billion government bailout in 2008, plunging into the red by £5.2 billion in 2012.
Asked about Sir Mervyn's comments on RBS, David Cameron's official spokesman told a Westminster media briefing: "The Prime Minister's and the Government's view is that what we are doing around the implementation of the Vickers proposals around ring-fencing of investment banking and riskier activities - relative to high street activities - is the right thing to be doing."