Part-nationalised RBS shocked the City by posting a pre-tax loss of £634 million for the third quarter of its financial year after being hit by an additional £250m provision for payment protection insurance mis-selling and higher than expected losses on toxic loans as well as movements on the value of its own credit.
The bank warned that the creation of a £38 billion internal bad bank, a more limited measure than the complete split demanded by some politicians, would lead to increased impairment charges of up to £4.5bn in the coming three months.
Meanwhile, chairman Sir Philip Hampton cautioned that half of the £45bn raised from the taxpayer in 2008 is now "dead money" due to spending on consumer compensation and fines and various fees.
A report by former Bank of England deputy governor Sir Andrew Large into RBS's small business lending practices concluded that it "overshot" when cutting back lending from an "unsustainably high" share of the market in 2008.
Sir Andrew said: "The bank has failed to meet its own SME (small and medium-sized enterprise) lending targets, partly because they were unrealistic and also because of weaknesses in its lending operations."
Sir Andrew criticised RBS for its poorly trained staff who don't understand the bank's lending criteria.
Mr McEwan said: "The pendulum of risk aversion swung very hard to one side. The pendulum needs to move back down."
He continued: "We want to make it not just the biggest SME bank but the best because it is clear that we are not and we want to be."
Mr McEwan said RBS hoped to turn its Ulster Bank subsidiary, which has been hamstrung by large property loan losses, into a success story. But he was more coy about the future of other parts of the business such as private bank Coutts.
RBS confirmed it is speeding up the flotation of its US bank Citizens, with the first shares offered next year and the sell-off completed by the end of 2016.
Mr McEwan said he intends to cut costs at the bank but declined to say how many jobs would go.
"What do customers value, what do they need and what will they pay for? We keep coming back to these simple things," he said.
The full details of his reforms will be set out in February. RBS has cut more than 40,000 jobs since 2008.
Dominic Hook, national officer at trade union Unite, said: "We believe it is impossible for the bank to improve customer service and slash more jobs at the same time."
Putting £38bn of loans into the "capital resolution division" next year, would also free up capital at a time when regulators want banks to increase their resilience against potential loan losses.
RBS aims to dispose of up to 70% of the assets over the next two years and remove them all from its balance sheet within three.
Chancellor of the Exchequer George Osborne, who visited RBS's London base yesterday said: "I think it does make it easier to sell off the bank and get our money back."
He added that a sell-off was unlikely to begin before 2015.
Ratings agency Fitch said the division "will reduce some of the tail risks for the bank".
Sir Philip said RBS's various conduct scandals have knocked its reform timetable back by a year but its overhaul will be largely done by the end of 2014.
RBS is in talks about releasing a provision that would force it to pay dividends to the Government before other investors.
Mr McEwan said: "We would like to see the UK public get their money back: not just in cash terms but in getting a really good bank back."
RBS's warning of a "substantial" full year loss sent its shares down 27.6p or 7.5% at 340p. The break-even point for the Government's 81% holding is 500p.