The bank that is 81 percent owned by the British government, which rescued RBS with $71.7 billion in bailout funds during the financial crisis, said it would create a separate business within the bank, a move applauded by chancellor of the Exchequer George Osborne.
"The bad bank should be an internal one, funded by RBS, rather than an external one funded by the taxpayer," Osborne said.
The New York Times reported that RBS planned to sell 70 percent the toxic assets within the next two years, while focusing on retail and commercial banking.
Creating a so-called "bad bank" should "create create a more resilient institution that is better able to support the real economy without any expectation of further government support," the Bank of England said in a statement.
RBS also said Friday it lost $1.3 billion in the third quarter compared to $2.2 billion loss in the third quarter of 2012.
Its share price dropped to about $5.50 Friday in early trading, down 3.9 percent, extending a significant gap from the $7 per share price the government would need to make a profit on the bailout.
Despite expected losses, the Times said the government is likely to begin selling its shares this year, five years after it stepped in to rescue the bank.
The bank is smaller by $1.4 trillion worth of assets and by 40,000 employees since the financial crisis began, the Times said.
On Friday, the bank said it would sell the Citizens Financial Group in the United States in 2014.
"We are a bank with a significant international reach but the U.K. is our home," said Ross McEwan, the bank's new chief executive officer, who took the CEO position in early October..