LONDON (Reuters) - Royal Bank of Scotland <RBS.L> will make a total contribution of 3.5 billion pounds ($5 billion) to its pension scheme over the coming years, clearing one hurdle blocking the bank's return to dividends.
The payments will start with a pre-tax contribution of 2 billion pounds in the second half of this year, the bank said.
They are required due to changes to the pension scheme caused by ring-fencing legislation, under which banks must separate their retail banking operations from riskier activities.
Up to another 1.5 billion pounds in payments will be made to match dividends from 2020 onwards. The initial payment will be recognized in the bank's second quarter figures this year and both will be taken from its core capital reserves.
The payments, agreed in a memorandum of understanding with the pension scheme's trustee, represent an "important milestone" towards the return of capital to shareholders, Chief Financial Officer Ewen Stevenson said in a statement.
"With these proposed payments... we will have substantially addressed the historical funding weakness that existed in the fund and brought clarity to future funding arrangements," he added.
RBS, 71 percent owned by the state after a bailout, in February reported its first annual profit in a decade and has not paid a dividend during that period.
While the payments resolve one issue standing in the way of the bank returning to dividends, a larger roadblock is a multi-billion dollar settlement with the U.S. Department of Justice over RBS's sale of toxic mortgage-backed securities in the run up to the financial crisis.
To comply with ring-fencing legislation, RBS is separating its investment banking unit from its UK-focused retail banking business.
This means it will also set up one pension scheme inside and another outside the ring-fenced bank, potentially leaving the one on the outside exposed to higher risks.
The bank said it also means entities outside of the ring fence will not be able to participate in the same defined benefit schemes as those inside.
It added that from 2019 its investment bank, NatWest Markets, and international business will no longer participate in its main pension scheme and will be transferred to the scheme outside of the ring fence.
($1 = 0.6983 pounds)
(Reporting by Emma Rumney; Editing by Sinead Cruise and Keith Weir)