Banking: City braced for £1.2bn losses at RBS after A&L's profit vanishes

The City is braced for Royal Bank of Scotland to report first-half losses of £1.2bn next week as the credit crunch continues to rebound through the banking sector.

The Edinburgh-based bank's smaller rival Alliance & Leicester provided fresh evidence of the severity of the crisis yesterday by reporting £2m of pre-tax profits for the six months to June compared with £290m a year ago.

But A&L's hit from the credit crunch is expected to be dwarfed by that of RBS, which is forecast to report a first-half loss - most likely the biggest in British banking history - of £5.9bn of write-downs on investments that have turned sour. Reuters published a consensus from five analysts for a £1.2bn loss compared with profits of £5bn in the first-half of 2007.

Britain's second-biggest bank reports on Friday, at the end of the half-yearly reporting season. Lloyds TSB and HBOS have already reported 70% falls in profits. While reporting a hefty loss, RBS will have healthier reserves after raising £12bn in a record-breaking cash call that became pressing after its role in the takeover of ABN Amro last year.

A&L's profits were wiped out by £209m of credit crunch write-downs, an additional £70m to cover the increased cost of borrowing and £14m of redundancy costs. Without these factors, A&L's profits would have been similar to last year's £301m.

Despite the erosion of profits, Citi analysts saw "nothing to dissuade Santander" from its bid for A&L, which will give investors one Santander share for every three in A&L, as well as an 18p dividend.

David Bennett, A&L's chief executive, said retail customers had not been put off saving with the bank during the months of rumours about its financial health. Retail deposits rose by £800m, though those for companies fell by £1.3bn after the bank lost the AA credit rating needed by some corporate customers to deposit money.

While the bank is barely profitable, its capital cushion is as strong as that of HBOS, which raised £4bn of new funds last month. A&L's core tier one capital ratio (the key measure of financial strength) is 6.5% - in the middle of HBOS's range.

A&L is assuming unemployment rises slowly, GDP achieves positive growth and house prices fall by up to 20% by the end of next year. If house prices fall 30% and unemployment rises by 20%, A&L would need to find up to £300m more capital.