Speaking to the Parliamentary Commission on Banking Standards, the Mervyn King said: “I do not think it is beyond the wit of man to restructure RBS”.

King told MPs while the UK had led the world in recapitalising the banks that with the right approach RBS could be transformed within a year.

He said the problems of RBS had clearly been a drag on lending to the UK economy:

“If you go back to the measures of 2008 and 2009, the idea was we needed to restructure the banking system. The medium of public ownership was the way in which they could be recapitalised and restructured and sold back to the private sector.”

Four years on, this had not been achieved, he said.

“That will need a more decisive approach to the restructuring and recapitalisation of the bank.”

The idea that a bank 82% owned by the taxpayer should be run at arm’s length did not make any sense, he added.

He told MPS that continuing losses would have to be separated from the healthy units on the RBS balance sheet:

“A new RBS ought to be a major lender to the UK economy rather than a lender that is contracting its lending because it has little choice.”

Former chancellor Nigel Lawson said he had discussed King’s argument with the Chancellor, George Osborne but the latter objected on political grounds, arguing that it would be impossible to present the prospect of more public money going in to banks to the public and the financial markets.

Lawson himself dismissed this view as ‘nonsense’.

King also defended the effects of Funding for Lending, saying it was designed with the understanding some major lenders would have to reduce their balance sheets because of legacy problems. He said: “We knew when we created the FLS that there were at least three major banks that were going to contract their lending to the UK economy and there was nothing we could do about it.

“What we could do is create a scheme that would allow them to contract less than they would have done.”

The scheme actually benefited small and medium businesses more than mortgage borrowers because the former was riskier, he said.