Royal Bank of Scotland said on Friday that bad debts had hit a “plateau” as it reported that losses had more than halved during the July to September quarter.

Operating losses during the quarter fell to £1.52 billion, down from £3.53 billion in April to June, as bad debts hit £3.27 billion — down from £4.66 billion in the previous quarter.

Stephen Hester, chief executive, said that the improvement in the bad debt position was an “important straw in the wind” that pointed to a recovery in the bank’s fortunes and lent credence to his pledge that taxpayers, who now own 84 per cent of RBS, would eventually see a profit on the sums pumped into the bank.

He said: “We believe we have seen, now, a plateauing of bad debts. In fact, bad debts, charges, are down, versus the prior quarter. We see them as plateauing, not getting worse. We think it may be a little while before they get better and that is an important move forward towards recovery.”

On the consumer side, Mr Hester said that while Ulster Bank and Citizens, the bank’s American division, had suffered increases in bad debts, the mortgage book was “behaving pretty well”, with most losses arising in credit cards and unsecured loans.

Mr Hester said that RBS had also “arrested” the decline in its margins — the difference between what it pays depositors and charges lenders — earlier than he had expected. It was now less dependent on funding its loan book from the wholesale market.

He said: “Progress is also being made to return us to balance sheet safety. Our wholseale funding is normalising and we are gaining market share, so our crucial loan-to-deposit ratio is improving in the way we said it would. But it will take some years for our core profitablity to return to the levels we need it to and, in that time, we need to work through our legacy of bad debt.

“This is a marathon and not a sprint. There are encouraging signs of progress in the economy, as well as in our own operations. I’m upbeat but realistic. We have a tough job but are making progress and I think we will see that gathering momentum in quarters to come.”

Mr Hester dismissed a fall in profits at GBM, the bank’s investment banking unit, which was in contrast to rising profits at rivals during the quarter. He said that it had been telegraphed to the market earlier in the year: “The business is going well. Overwhelmingly, we have recast this business to serve our customers and clearly we continue to work hard at that.”

Mr Hester admitted that GBM’s ability to hire high-quality staff was being hampered by government restrictions on pay and bonuses.

He said: “It has been a significant impediment this year and I expect it will be next year. I’m not complaining about that, I understand it completely — we ‘get it’. We have no problem leading the world on the subject of bonuses, but it is a tightrope, and we have to balance reform with having good people who can get the taxpayer value for money.”

Mr Hester insisted that no decision had been taken on whether RBS would try to side-step the effective ban on cash bonuses with higher base salaries, but he wanted to ensure that people are not rewarded for excessive risk-taking.

“On the current metrics, the profitability-to-pay ratio for RBS is better than the vast majority of our competitors. In other words, people are getting value for money ... We will pay as little as we can consistent with having a successful bank. We are getting on with the job — but I do want people to understand that it is only through RBS being successful that the taxpayer will get his or her money back.”

Mr Hester disagreed with calls for the creation of ‘narrow’ banks — where investment banking activity is hived off from the traditional activities of taking deposits, giving loans and making payments.

He added: “This crisis was not a crisis of the shape of banks or even the size of banks. In fact, by far and away the largest number of bank failures have been of narrow banks, whether narrow investment banks, or narrow mortgage banks or narrow consumer finance banks.

“So the evidence is in support of broad-based banks. Although there are very important public policy issues around the whole ‘too big to fail’ debate and I am totally supportive of regulatory progress in this area.”

Mr Hester said RBS had not ruled out a possible rights issue at some point. “We want to reverse the pattern of government ownership in this bank. We will look carefully at investor appetite and keep an open mind on how we can reduce the Government’s stake.”

The results were better than expected and the shares rose 0.89p to 36.1p.

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