RETURNING Royal Bank of Scotland to the private sector would unleash improved performance, its chief executive Stephen Hester claimed as the bank returned to profitability.

The 81% state-owned bank said its clean-up would be largely complete in the next year, when it could begin preparing with the Treasury to sell the Government's shares. But the performance of RBS's core businesses, especially its investment bank and corporate lending arm, worried the City and its shares plunged 5.7%.

The Edinburgh-based bank also warned of job losses to come as it seeks to cope with a lacklustre economy.

Mr Hester said: "In the psychology of the country, the difficult economic times since 2007 have become synonymous with RBS and Lloyds needing a bail-out. From a country standpoint, reprivatisation of the bank has a psychological benefit next to the financial benefit for the Government having that money."

The mindset of RBS staff and customers too is tainted by its history, he said.

"I believe as we put this behind us, part is changing the bank, part is changing the shareholders, that will unleash an improved performance at RBS ."

The bank's chairman, Sir Philip Hampton, said the aim was to have a business that was performing well so the bank could start preparing a prospectus with the Government for a sale from the middle of 2014.

"It could be earlier – that is a matter for the Government," Sir Philip said.

Mr Hester said share sales were likely to happen in stages in line with the privatisations of the 1990s. But hopes of a profitable exit for the taxpayer were further dented by a 17.5p fall in RBS's shares to 289.8p.

The taxpayer paid 500p a share for RBS shares and they are valued at 407p on the Treasury's books.

This means the Government is sitting on a paper loss of £24bn on the £45bn spent bailing out the bank.

Peter Hahn, lecturer at Cass Business School, said the focus should not be on whether the taxpayer will make a profit. "HM Treasury should be looking at every penny received as found money," he said.

Talk of RBS's privatisation comes despite great uncertainty surrounding the bank.

Government plans to force institutions to ring-fence their retail banking business from their investment banks have yet to be implemented. The City regulator is demanding banks hold more capital, but has yet to tell each one the size of its shortfall.

Meanwhile, RBS faces legal action in the UK and US from aggrieved investors who participated in fundraisings by the bank before its near collapse in 2008.

Ian Gordon, analyst at Investec, said: "We were bemused listening to RBS's management describe the business as 'ready for privatisation in 12 months'. It is ready now – it was ready three years ago – surely the only issue we are actually discussing here is the price?"

The share slump came as RBS posted a pre-tax profit of £826 million for the first three months of 2012, its best performance since the third quarter of 2011, but its operating pre-tax profit of £829m was well adrift of the £1.2bn investors expected.

While losses from bad debts are falling, revenues are far lower than expected – with total income in its investment bank, which has shed 2000 employees in the past year, down 40% year-on-year to £1bn and a fall of two-thirds in operating pre-tax profit to £278m. "It is not surprising our operating results are soft, given the conditions our customers are experiencing," Mr Hester said.

He was lukewarm towards proposals that RBS be split into "good" and "bad" banks to allow the institution to prosper without the weight of bad debts. "I believe we can finish the job without any taxpayer support," he said.

After being forced by regulators to put in place plans to sell a stake in its US bank Citizens and further scale back its investment bank to improve its capital position, Mr Hester appealed for less intervention. He also said the bank would have to continue to cut costs, and more job losses are likely.