ROYAL Bank of Scotland is considering abandoning the £7 billion sale of its insurance operations, as fears grow that it is likely to announce a new year profits warning.

The government-controlled bank has rejected an initial offer from CVC Capital Partners for the insurance operations, which includes the Direct Line and Churchill brands, according to industry sources.

Although RBS has not ruled out a deal with CVC, it has recommenced talks with a second private-equity firm, thought to be BC Partners.

However, it is increasingly unlikely either bidder will make an offer RBS will accept. It is understood that the bank is close to abandoning the sale altogether.

Although no final decision has been taken, an announcement is possible within the next few weeks.

Stephen Hester, RBS’s new chief executive, has pledged to focus on the group’s UK business, hinting at possible disposals of overseas operations.

RBS’s 4.3% stake in Bank of China, estimated to be worth more than £1.5 billion, could ultimately come on to the auction block.

The UK insurance operations, which generate substantial cash flow, are considered more valuable to the group now than they were under the previous management. It was focused on international expansion.

Negotiations around the insurance sale come amid increasing expectations that the bank will be forced into issuing a profit warning ahead of its full-year results.

Moody’s warned last week that it may downgrade RBS’s credit ratings over concerns about its huge exposures to commercial property in the UK, Ireland and the US and the rapidly slowing UK economy.

The ratings agency also raised concerns of further writedowns from the bank’s global banking and markets division, and losses of up to £400m from exposures to Bernard Madoff’s alleged fraud.

Analysts at UBS have already warned that the bank may record losses of up to £28 billion with its full-year figures, if it takes an extremely aggressive attitude to the valuation of the assets it bought from Dutch bank ABN Amro last year.

Losses on this scale would tip the bank towards full-scale nationalisation. The government already owns 57.9% of RBS’s shares and has not ruled out further investments.

Analysts at Credit Suisse have predicted that the UK’s big banks — RBS, Barclays and the combined Lloyds Banking Group — will suffer impairment charges of £60 billion in 2009 as bad debts mount in the face of the global recession.

Debate rages between the Treasury and Bank of England over whether or not the banks will require further capital.

Alistair Darling, the chancellor, said banks should be allowed to absorb losses even if this hits their capital ratios further. Charles Bean, deputy governor of the Bank of England, has suggested more state capital raisings may be necessary.

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