State-backed Royal Bank of Scotland (RBS) said it was on the path to recovery as it reported a better-than-expected first-quarter operating profit and a big reduction in its balance sheet.

RBS, which is 82 per cent owned by the UK government after being rescued during the 2008 financial crisis, on Friday reported a first quarter operating profit of 1.2 billion pounds ($1.9 billion), compared with a loss of 144 million the previous quarter and a consensus forecast of 800 million.

Chief Executive Stephen Hester also confirmed that the bank will next week finish paying back the emergency loans it received from the British government in the midst of the financial crisis. It will also recommence payment of dividends and coupons on hybrid capital.

Profits were led by its reshaped and streamlined investment bank, which bounced back to an operating profit of 824 million pounds in the quarter from a 109 million pounds loss in the previous three months as capital markets improved.

Revenues in its new markets unit were 1.7 billion pounds, more than double the fourth quarter but down 18 per cent from a strong year ago period. RBS also spent 271 million pounds restructuring the investment bank.

"We are happy with progress in the first quarter although the economic and regulatory backdrop remains tough," said Hester. "RBS continues, markedly, to regain strength and resilience."

Hester said the bank was making excellent progress in removing the "mistakes" of the past" with non-core assets being shrunk and liquidity strengthening.

RBS said its funded balance sheet had decreased by a further 27 billion pounds to 950 billion. It has reduced its short-term wholesale funding by 23 billion to 80 billion. Non-core funded assets were down 11 billion to 83 billion. – Reuters