UPDATE 2-UK's RBS near deal on toxic asset scheme-sources

By Clara Ferreira-Marques

LONDON, Oct 31 (Reuters) - Royal Bank of Scotland is close to agreeing more flexible terms on a government insurance scheme for bad debts, in a deal that will include asset sales to appease EU antitrust concerns, sources close to the deal said.

The so-called Asset Protection Scheme (APS) was first agreed earlier this year as insurance to protect part-nationalised RBS and rival Lloyds Banking Group from potentially crippling losses from toxic loans. But a rosier economic backdrop has prompted both to reconsider the costly plan.

Lloyds, 43 percent owned by the state, is expected to announce next week it has pulled free of the APS, raising cash in the market instead..

RBS, 70-percent state-owned, does not aim to avoid the APS entirely, but the new terms being finalised this weekend with the UK government and Brussels should allow it to avoid an upfront fee agreed in March of up to 17.5 billion pounds ($29 billion) to join the APS for five years.

Instead, the bank will pay annually, under a 'pay-as-you-go' arrangement whereby the premium depends on the toxic assets needing to be insured, the sources said on Saturday.

One of the sources said the change meant the APS now offered 'worse-case-scenario' -- rather than standard -- insurance.

In exchange, RBS will agree take on a higher proportion of the initial losses, the sources said.

That could be as high as 60 billion pounds -- compared to a first loss of 19.5 billion in the original deal plus 23 billion of losses absorbed since the scheme was announced in March -- though at least one source said the number would be lower.

All of the sources, however, cautioned no decision had yet been taken, though all sides hope the deal can be announced together with the Lloyds package as early as Tuesday.

A Treasury source said it was too soon for details, but said the Chancellor was expected to take a final decision this weekend, with an announcement due next week.



SELLING CHURCHILL

Any agreement with the government and Brussels is also expected to include asset sales to ease capital requirement and competition worries. These are set to include the bank's insurance arm -- with top brands Direct Line and Churchill -- and RBS-branded branches in England and Wales.

A British government source had told Reuters on Friday that RBS was likely to sell its insurance operations and other assets to help reduce the size of its balance sheet.

The 312 RBS-branded branches in England and Wales -- which mainly focus on business lending -- would directly satisfy EU concerns over RBS's position in the market for banking for small and medium-size enterprises.

But -- crucially -- the deal should avoid the sale of RBS's U.S. arm Citizens.

RBS could also trim back its investment bank. One of the sources said on Saturday RBS was expected to agree to shrinking the balance sheet of its Global Banking and Markets business, but gave no details.

RBS declined to comment. A spokesman for EU Competition Commissioner Neelie Kroes also declined to comment. (Additional reporting by Foo Yunchee in Brussels) ($1=.6041 Pound) Keywords: RBS/ ([e-mail]; [phone]; Reuters Messaging: rm://[e-mail]) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.