LONDON - Royal Bank of Scotland said investors were concerned a clampdown on bonuses would hamper its ability to retain staff and warned parliamentarians the rescued bank could find itself prisoner to market rates.

RBS Chief Executive Stephen Hester has on several occasions said pay restrictions forced the bank to walk a difficult tightrope, balancing its turnaround efforts, shorter-term political pressures and public outrage over banker pay.

The lender, 84 percent state-owned as a result of its rescue by the government, was forced to agree to restrictive terms in order to join an insurance scheme for bad debts, including a clause which hands the Treasury a veto on the 2009 bonus pool. That added to an existing agreement to ban cash bonuses for staff earning over 39,000 pounds.

Speaking several weeks ahead of the bank's final bonus decisions, Hester told lawmakers during a parliamentary hearing on Tuesday that shareholders had raised concerns about our ability to keep and motivate the good people.

He said the bank aimed to pay the minimum we can get away with in the market place, but said it could have little choice: RBS will be a part-prisoner of the market place.

RBS is due to make its bonus decisions by late February.

Hester, quizzed by parliament's Treasury Select Committee as part of a series of testimonies from Britain's bailed-out lenders on Tuesday, also offered positive news for its top shareholder, telling lawmakers its recovery was ahead of plan.

We are well ahead of where I thought we would be. We did not slip on as many banana skins as I thought we might, he said. That gives me encouragement to believe we can hit all the ambitious targets we put out for the recovery of RBS.

RBS is two thirds of the way to cutting the size of its balance sheet in line with its plan and had approximately halved the size of its investment bank, the heart of most of its problems during the crisis, Hester said.
The core businesses of RBS are really good businesses... and they will provide the wherewithal to pay back the taxpayers, he said. I would be hopeful that there will be a number of opportunities for share sales to be made at a profit over the next three to four years, he said.

RBS, whose losses put it at the centre of the financial crisis, has also been at the heart of the debate on banker bonuses and the government's role in changing behaviour.

News last month of strings attached to the bank's bonus pool prompted Hester to criticise a growing politicisation of the bank and sparked rumours the board had threatened to walk out.

Hester reiterated on Tuesday that the board had not threatened to step down, but had been advised that some aspects of its operational freedom had been signed away as part of the insurance deal and could, if mismanaged, restrict the board's ability to carry out its duties.

He did, however, warn of a rising risk of political interference ahead of a British general election due by June.

NOT HOODWINKED

Lloyds Banking Group, 43 percent state-owned, spoke at the tail end of a lengthy morning of questioning, again defending its takeover of virtually collapsed rival HBOS.

Chief Executive Eric Daniels, who has come under fire for failing to tell shareholders HBOS was being propped up with 25 billion pounds from the Bank of England, said on Tuesday he felt disclosure had been thorough and appropriate.

I don't believe that anyone was hoodwinked, he told lawmakers. I do believe that the HBOS acquisition by Lloyds will prove to be very good value for all our stakeholders over the medium term.

Lloyds, like RBS, has faced tough retail and business lending targets in return for its government rescue. Both banks said they had met mortgage lending targets but were lagging in business loans as small and medium enterprises chose instead to repay their debts.

Nationalised Northern Rock, the first British casualty of the credit crunch, is also one of the most high profile assets the government will have to sell in the medium term. As of this month, it has been restructured and split in two to ease a sale.

Chief Executive Gary Hoffman said the loss-making bank had had some informal discussions with suitors, but no deadline had been set.

(Additional reporting by Steve Slater, Paul Hoskins and Sarah Young; Editing by Dan Lalor and Louise Heavens)

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