Pedestrians are reflected in the window of a branch of the Royal Bank of Scotland in London. Picture: Suzanne Plunkett

Virgin Money has emerged as a frontrunner in a small field of potential suitors to buy 316 branches from majority state-owned Royal Bank of Scotland, after Santander pulled out of a deal on Friday.

The collapse of the sale was a major blow to RBS, coming at a critical juncture in its recovery plan and it is now likely to have to accept a price well under the 1.65 billion pounds ($2.65 billion) agreed with Santander.

Shares in RBS, which is 82 percent owned by the British taxpayer, were down 0.9 percent in early Monday trading. Shares in Santander edged up 0.1 percent.

“RBS now has only 13 months to find another buyer or float the business. Either way, we expect the revised price to be significantly lower,” said Shailesh Raikundlia, analyst at Espirito Santo, who viewed the breakdown of the deal as positive news for Santander.

Santander's retreat will save it some capital and avoid a big increase in its UK loan book and exposure at a time of strain in its domestic market and scrutiny of its capital and funding. Raikundlia said it was positive for the Spanish bank.

“The price set in Aug 2010 looks somewhat expensive now, the UK macro environment doesn't look appealing in the medium term and capital preservation ranks as a higher priority,” he said.

Although Richard Branson's Virgin Money has emerged as a possible alternative bidder, RBS faces a tough task to clinch a sale by a 2013 deadline.

Sources close to the matter told Reuters that RBS had received interest from Virgin Money, which lost out to Santander in the original auction, and others since Friday. However, the list of obvious rival bidders is short.

US private equity firm JC Flowers is interested in a potential bid, with the firm keen to expand its small regional lender One Savings Bank, the Financial Times reported.

NBNK, the venture set up to buy UK banking assets by former Lloyd's of London insurance head Peter Levene, is being wound up after losing out to the Co-op in a battle to buy more than 600 branches from Lloyds Banking Group and the chances of it reversing that process looked slim after its former head Gary Hoffman was on Monday named CEO of Hastings Insurance.

Co-op's preoccupation with integrating the branches it purchased from Lloyds makes it an unlikely bidder. Metro Bank said on Sunday it was focused on organic growth, while Tesco Bank said it had no interest in buying branch networks.

Sweden's Handelsbanken, which is expanding rapidly in Britain, declined to say if it was interested in the branches but has so far focused on organic growth in the UK.

Australia's National Australia Bank was involved in the original auction but has since begun a retreat from the UK market, shutting several branches and cutting 1,400 jobs.

If a credible bidder fails to emerge, RBS could consider a stock market listing as a back up option.

RBS received a welcome boost last week when it successfully completed the initial public offering of its insurance arm Direct Line and later this month could exit a costly government insurance scheme.

But those milestones risk being overshadowed because the bank is expected to be next in line to be hit with a big fine for the manipulation of Libor global interest rates.

RBS was ordered by European authorities to sell the branches, which have 1.8 million customers, as a condition of being bailed during the 2008 financial crisis.

The setback could push back the time frame for taxpayers to see a return on the 45 billion pounds Britain pumped into the bank to keep it afloat. - Reuters