By Matt Scuffham and Steve Slater

LONDON (Reuters) - Splitting up part-nationalized Royal Bank of Scotland (RBS) will be put forward as an option by lawmakers examining standards in British banking, political and industry sources said on Tuesday.

The bank's division would allow its toxic assets to be grouped into a "bad bank" separate from its profitable business, freeing it to make the increased lending that the economy needs, but has been rejected so far since it could be complicated and expensive for the government to administer.

The sources said the Parliamentary Commission on Banking Standards is likely to lay out the pros and cons of such a move, but will stop short of making outright recommendations on the bank's future when it publishes its final report later in June.

Britain set up the cross-party commission last year to look at ethics in banking, after Barclays Plc was fined over the manipulation of global interest rate benchmarks.

Some members of the commission, notably former British finance minister Nigel Lawson, are known to support hiving off RBS's toxic assets into a bad bank.

Yet the commission took little public evidence on the issue, making other members reluctant to make a firm recommendation on the matter.

Outgoing Bank of England governor Mervyn King brought the issue to the fore when he recommended a breakup of RBS in the last of the inquiry's 73 witness sessions.

RBS has already undergone a massive restructuring since the government pumped in 45.8 billion pounds ($70 billion) in 2008 to keep it afloat, leaving taxpayers with an 81 percent stake.

COST-BENEFIT

The separate cross-party Treasury Select Committee, on which five members of the Banking Standards Commission also sit, has recommended the finance ministry should examine a possible breakup and produce a cost-benefit analysis.

But the Treasury has yet to respond to that request.

Finance Minister George Osborne has said he would think twice about breaking up RBS because of the expense and complexity involved.

Britain is looking at options for re-privatizing both RBS and Lloyds Banking Group Plc , in which it holds a 39 percent stake. Offloading its shares in Lloyds would be more straightforward, given they are trading above the price at which the government considers it would break even.

Shares in RBS are trading well below the government's break-even price and Treasury officials are looking at other options, such as a mass share giveaway to the British public.

Members of the Banking Standards Commission are reviewing a final draft of their 600-page report and will meet next Monday and Tuesday to debate final recommendations.

Sources said the draft report has been prepared by officials working for the commission's chairman, Conservative lawmaker Andrew Tyrie, and was handed down to the nine other lawmakers on the commission late last week.

The draft incorporates proposals relating to all issues on which the commission has heard evidence and not all of them will make it into the final report.

Sources have said Tyrie is aiming to publish the report in the week starting June 17, but that is subject to delay if a consensus cannot be agreed. Members of the commission have said they want unanimous agreement on the final recommendations.

(Editing by Sinead Cruise and David Holmes)

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