Bill Jamieson: So what exactly does Hester have to do – and what might the new Royal Bank look like under his tough stewardship?

A HOST of tough decisions face Stephen Hester, the Royal Bank's new chief executive, when he moves in to the top suite at Gogarburn on 21 November.

Top of the agenda is to get a detailed review under way of the group's sprawling operations here and around the world. He needs to slash the balance sheet exposures and tackle the risk concentrations that have brought the group to its knees. At the same time, he needs to get disposals and cost reductions under way.

And he has to do all this soon. For he has publicly set himself a target – that is to get shot of the government's high coupon preference shares and prepare the way for a promised resumption of dividends some time in 2010. To do that in normal market conditions is ambition enough. But the problem is how to manage an ordered de-leveraging of the business and successful sell-offs in the teeth of what is shaping up to be the worst recession for a generation.

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The fear is that Hester will do what he did at Abbey: take a bank that had lost its way, be ruthless with the problem operations and shrink it to a much smaller core of stable, utility-style businesses. Something similar looks in store for RBS: UK retail and business banking for small and medium-sized firms looks relatively safe. But much of the corporate activities here and overseas will be shrunk.

Disposals would be the gentle way to do this. Unfortunately, the market for financial assets at present is dire. No-one at RBS wants to see a firesale of businesses at mark to market prices. So the whole exercise of restructuring and getting RBS back to health is deeply conditional on an improvement in market confidence and conditions.

So what is likely to go, and what to stay? The household name insurance operations of Churchill and Direct Line are already up for sale, detailed discussions have been held with several potential buyers, there is now a shortlist and bank executives are hopeful of a sale by February.

Elsewhere, I would expect to see a vigorous thinning-out rather than drastic chopping of the group's presence in key markets. The wholesale global markets and banking division, source of some of the acute problems, boasted relationships with more than 96 per cent of FTSE100 companies and in the United States more than 80 per cent of Fortune 100 companies. The business world has been convulsed since these grandiose claims, and this division is set to see big retrenchment, here and in the US. The skill will be in achieving cuts in operations without compromising market presence in strategic areas. "We will still be in Asia", said a senior RBS source, "but do we need to be in 23 countries in Asia?"

Under the new regime, Hester has "strategic biases". The aim is to come through the recession with a steady state of powerful, stable, customer-facing franchises with attractive market positions and ability to show growth in Return on Equity. Businesses will have to restate and demonstrate their value. And if they fail, they will be downsized or sold.

Hester wants to get RBS focused on a capital-allocation approach with attention to earnings return – an approach that sounds similar to that Arnold Weinstock deployed with ruthless determination at GEC in his heyday. Some 70 per cent of the bank's businesses are thought likely to be able to demonstrate they can meet these criteria. However, the remaining 30 per cent will require what an RBS source described yesterday as "more difficult decisions".

UK and Scottish retail banking operations (return on equity 21 per cent, compared with 11 per cent in the US and just 3 per cent in Asia) look to be relatively safe, though some scaling back will be inevitable with ferociously tougher market conditions.