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LONDON (Reuters) - Spain's Santander pulled out of its 1.65 billion pound deal to buy 316 UK branches from Royal Bank of Scotland late on Friday, dealing a sharp blow to the state-backed British bank.
More than two years after the deal was struck, it collapsed because the process of carving out the business proved more complex and difficult than had been expected. Santander said it was unwilling to again extend the deadline when it became clear that it would not be completed this year.
RBS, 83 percent owned by the British taxpayer, said it would restart the sale process, which had been ordered by European authorities as a cost for Britain's rescue of RBS in 2008.
RBS could ask for an extension of the deadline. It may struggle to find a new buyer, however, and may have to accept a lower price or consider a flotation.
Santander UK agreed to buy the branches and the business of 1.8 million customers in August 2010, but technology and separation issues pushed back the original December 2011 completion date.
Santander UK Chief Executive Ana Botin said on Friday that she had wanted to take the business in "a steady state" and added: "We have concluded that given delays it is not possible to complete this within a reasonable timeframe."
A report by consultancy Accenture estimated that the transfer of retail customers would not be completed until 2014, and the transfer of corporate customers would not be completed until 2015, Santander said.
The bank said the deal had no chance of being completed by a February 2013 deadline, allowing it to walk away with no break fee.
Santander saw off competition from National Australia Bank, start-up bank NBNK and Richard Branson's Virgin Money to buy the branches, as it was particularly keen to have the 244,000 business customers among the bank's clients.
The Spanish bank was keen to bulk up ahead of a planned flotation of its UK arm. It still wants to separate and list the business, but that is seen as being unlikely in the near future due to depressed UK bank valuations.
Virgin bought nationalised bank Northern Rock and may be the keenest to return for another look if it wants to bulk up.
RBS Chief Executive Stephen Hester faces more bad news as his bank is expected to be next in line to be hit with a big fine for the alleged manipulation of Libor global interest rates.
That and the collapse of the branches deal could overshadow two milestones this month that Hester had hoped would show his bank as being well on the road to recovery. It completed the initial public offering of its insurance arm Direct Line this week and later this month could exit a costly government insurance scheme.
The setback could further push back the timeframe for taxpayers to see a return on the 45 billion pound RBS bailout.
A Treasury spokesperson said the deal's collapse was a commercial matter for RBS and Santander, and said the government remained "determined to promote greater competition in the banking sector".
Hester said the work separating the branches would not be wasted.
"Much of the heavy lifting associated with a transfer has already been completed, including separating data for 1.8 million customers and putting in place a standalone management team," Hester said. He added that it was "disappointing" that Santander had pulled out, especially for customers and staff.
The affected business made an operating profit of 186 million pounds in the first six months of this year and has 21.7 billion in customer deposits and loans representing 86 percent of deposits.
Santander's purchase price when the deal was struck represented a 350 million pound premium to net asset value of 1.3 billion at the end of 2009. The price of the deal could have risen to 2 billion pounds or dropped to about 1.3 billion upon completion, depending on certain criteria.
Reporting by Steve Slater; Editing by Gerald E. McCormick and Theodore d'Afflisio