Royal Bank of Scotland (RBS) - which is 70%-owned by the taxpayer - could be loss-making for two years because of toxic debt on its balance sheet.
The bailed-out bank has reported a loss of £857 million in the first three months of the year as a result of soaring bad debts.
RBS' loss announcement follows fellow taxpayer-owned bank, Lloyds Banking Group, warning shareholders it will make a loss in 2009. Meanwhile Barclays, which has not yet taken any government bailouts, has reported a sharp rise in profits.
RBS' bad debts climbed to £2.9 billion from £656 million a year ago amid soaring corporate and retail impairments.
However, the banking group, which includes NatWest, did enjoy record income during the quarter of £9.7 billion mainly due to a strong performance at its global banking and markets division. It says it would have posted a £4 billion operating profit if it hadn't been for the £4.9 billion of bad debt writedowns and the plunging value of its toxic assets.
Dividend payouts on government preference shares, the effect of record low interest rates on margins and money due to partners on the sale of its Bank of China stake also widened losses at the bank.
And Stephen Hester, RBS' newly appointed chief executive, warns that further trouble lies ahead: "Some commentators are beginning to talk about economic recovery; we remain cautious and continue to plan and manage our businesses in the full expectation that both 2009 and 2010 will be very tough years for RBS."
RBS, which earlier this week announced the final stage of its management revamp, also revealed that it is still finalising details on which toxic assets will be included in the government's Asset Protection Scheme. It announced plans to insure £300 billion of toxic assets earlier in the year, with it liable for the first £19.5 billion of potential losses and the government for the rest.
The struggling group expects up to 85% of the impairments and credit market losses announced in its quarter one results to count towards its first loss. This means it has already burnt through about £4 billion of its buffer.
Alex Potter, an analyst at Collins Stewart, says: “2009 and 2010 will be tough for RBS. We assume it will be loss-making for at least two years and see little meaningful profit before 2012.”
Other analysts expect Hester, who took over from Sir Fred Goodwin in November, to sell off more assets and unwind huge loan books to get the bank back on track.
RBS' chief executive has warned that recovery will be a long, slow path. He said: "No one should be in any doubt that it is a process that will take years not months."
In 2008, the bank reported a loss of £24.1 billion – the largest ever annual corporate loss.