Royal Bank of Scotland posted the largest 2009 loss of its European peers but shrank from record-breaking levels, despite a sharp jump in bad debts which it says may now have peaked.

Part-nationalized RBS said its operating loss for the year was a better-than-expected 6.2 billion pounds ($9.51 billion), which compares to 6.9 billion pounds ($10.6 billion) a year ago.

RBS, which had struck a cautious tone at the half-year, gave investors more room for hope on Thursday, signaling a cautiously encouraging outlook and improvements at its investment bank, though 2010 will be a year of hard slog.

At around 0930 GMT shares were up 6.3 percent at 38.4 pence -- still well below the 50.5p average price at which the government bought its stake -- as investors were encouraged by a strong performance by its investment banking arm, Global Banking and Markets, and a more confident outlook for bad debts.

The results send a lot of positive signals... impairment trends look better than I generally expected, analyst Joseph Dickerson at Execution said. GBM looks strong relative to most peers, with the exception of Barclays.

Chief executive Stephen Hester said RBS, 84 percent state-owned, had balanced external political and public pressure to clamp down on payouts to staff with the need to pay competitive rates, adding its decision to pay around 1.3 billion in bonuses was not imposed from outside.

We were treading an unenviable tightrope, Hester told reporters. We believe that in the context of the industry in which we operate we have been restrained and responsible.

Hester has repeatedly said staff losses have been damaging but not destructive, but he said on Thursday that keeping and attracting talent was still his single biggest problem.

RBS has been a lightning rod for public anger over bank excesses and pay, but the bank said it had received government consent for its pared-down bonus pool and confirmed Hester would waive his bonus.

RBS said its compensation/revenues ratio was 27 percent, well below last year's level of around 80 percent, inflated by dramatically reduced revenues, and below peers including Deutsche Bank and Barclays .

INVESTMENT BANK PROFITS ARE BACK

RBS said impairments rose sharply to 13.9 billion, from 7.4 billion a year ago, but appear to have peaked. Fourth-quarter impairments fell 5 percent on the third quarter.

Global Banking and Markets, RBS's investment bank arm, provided a rare bright spot for the bank at the half year and did the same again for the 12 months -- swinging out of the red with an operating profit of 5.7 billion pounds.

That compares to a loss of 1.8 billion, despite a return to normal conditions after a bumper start to 2009 for the sector.

The bank said fourth-quarter revenues were flat on the previous three months and profits were healthy, faring better than rivals who have on average seen a slowdown of a third.

It also saw signs of recovery in its retail and commercial banking arm, with margins for the core divisions improving in the second half as it begins to reprice assets.

RBS also said it was making progress on asset sales forced on it by European competition authorities.

Its payment processing business WorldPay has attracted considerable buyer interest but the sale of over 300 branches is complex and not expected until 2011, it said.

The bank said the sale of UK bank branches, focused on small and medium-sized business banking, had not attracted the same queue as its global payment processing arm, but would still hit a sweet spot for some buyers.

Information documents on both are being issued to buyers.

Other commitments linked to state aid included lending commitments RBS agreed with the UK government. The bank said it had complied with the letter and spirit, but net business lending was actually down on 2008 by over 12 billion pounds as companies repaid debts and fewer sought fresh loans.

RBS posted a net loss attributable to shareholders of 3.6 billion pounds, from 24.3 billion a year ago, the largest ever UK corporate loss. Analysts polled by Thomson Reuters I/B/E/S/ had expected a bottom line loss of 5.7 billion. A consensus operating loss provided by the company was 6.5 billion.

The bank said its core business virtually doubled operating profit to 8.3 billion pounds, thanks to its investment banking arm, while losses for non-core businesses, which include assets up for sale and to be wound down, widened to 14.6 billion.

The bank said it had a year-end core Tier 1 of 11 percent.

($1=0.6521 pounds)

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