* RBS Insurance, branches set to go - sources
* Terms to also include cuts in investment banking ops
* RBS, Lloyds expected to announce plans this week
* RBS shares down 7.8 percent; Lloyds down 2.5 percent
* For a related column please double click on
(Adds comments from Virgin, FSA, details)
By Clara Ferreira-Marques
LONDON, Nov 2 (Reuters) - Royal Bank of Scotland said it would be forced to sell more assets than it had expected and axe 3,700 jobs from its retail business as another radical shake-up loomed for Britain's banks.
European competition authorities are set to force RBS to sell its insurance arm and over 300 branches, and shrink investment banking operations, according to people familiar with the matter.
The worse-than-expected terms sent shares in part-nationalised RBS down 8 percent on Monday. RBS said it was consulting with staff and representatives over a restructuring of its retail banking division which would see 14 percent of staff at its 2,268 British branches losing their jobs.
The cuts come with RBS having already shed 16,000 of its 165,000 staff globally since October 2008, including 10,000 jobs in Britain.
The bank said it had 30 percent more staff carrying out administrative duties per customer than competitors in Britain but was under-invested in its branches and customer infrastructure.
"We need to do better for all customers and shareholders by modernising the way we operate as a bank," said Brian Hartzer, chief exeutive of UK retail, wealth management and Ulster Bank.
RBS and Lloyds Banking Group Plc have been locked in negotiations for months with the British government over an insurance scheme for bad debts and are in parallel talks with the Treasury and EU over measures to compensate for billions received in state aid.
Plans for both banks are due to be made public this week, possibly on Tuesday, sources close to the deal have said, as part of a deal which will include large-scale disposals and which the government hopes will create new retail banks.
State-owned Northern Rock is also being broken up under a plan approved by European regulators last week.
RBS said on Monday its deal will include "divestments not initially contemplated", but said it was sticking to its turnaround plan.
It was further evidence that Brussels is taking a hard line with banks who took state aid, after imposing big changes on Dutch bancassurer ING Group NV last week.
Sempra Energy said it had been informed by RBS it may have to sell its interest in their joint venture.
Shares in RBS tumbled as low as 36.15 pence but pared losses and closed down 7.8 percent at 38.65p. Lloyds shares were down 2.33 percent at 84.68p.
VALUATION NEUTRAL
"While details remain sketchy, our reading of the 'new' plan for RBS is fairly valuation neutral, but with increased execution risk and raising further questions about the quality of its balance sheet," Jonathan Pierce, analyst at Credit Suisse, said in a note to clients.
A British government source had told Reuters on Friday RBS was likely to sell its insurance operations, which include the Churchill and Direct Line brands, along with other assets to help reduce the size of its balance sheet.
RBS had put its RBS Insurance unit, Britain's largest car insurer, on the block in 2008 but scrapped the sale this year after failing to garner enough interest.
Any deal should, however, avoid the sale of RBS's U.S. arm Citizens -- seen as a "red line" issue for RBS Chief Executive Stephen Hester.
But the bank will need to sell 312 RBS-branded branches in England and Wales, which mainly focus on small business lending, a source close to the matter said.
"In our view it appears that the authorities are intent on imposing tougher sanctions on RBS," analysts at Cazenove said. "In what is still an uncertain picture, potentially the dilution to RBS from the sale of (RBS) Insurance as well as (the) demerger of branches could dilute potential earnings by 10 percent."
Lloyds is set to be told to sell its Cheltenham & Gloucester branch network, Lloyds TSB Scotland and internet banking unit Intelligent Finance, sources familiar with the matter have said.
FLEXIBLE FRIENDS
Virgin Group is interested in looking at assets of three British banks which are going to be privatised, Virgin President Richard Branson said..
Britain's leading retailer Tesco Plc, as well as overseas banks Santander SA and National Australia Bank Ltd are also possible suitors, though Britain may limit banks with an existing presence in the market from bidding.
RBS said it was close to agreeing more flexible terms on the state-backed Asset Protection Scheme (APS), avoiding an upfront fee agreed in March of up to 17.5 billion pounds ($28.7 billion) to join the APS for five years, sources close to the deal said on Saturday.
Instead the bank will pay annually under a "pay-as-you-go" arrangement whereby the premium depends on the assets insured.
It is likely to see Britain's stake in RBS rise to 84 percent from 70 percent.
Lloyds is expected to announce this next week it has pulled free of the APS entirely, raising cash in the market instead and keeping the state's holding at 43 percent..
Lloyds will raise at least 12 billion pounds and up to 13.5 billion in a rights issue, with an additional 7 billion raised in so-called contingent capital, several sources have said.
For a graph on bank share performance, click on:
http://graphics.thomsonreuters.com/119/EZ_BNKGOV1109.gif (Additional reporting by Matt Scuffham, Myles Neligan and Steve Slater in London, with Nigel Tutt in Milan; Editing by Simon Jessop and David Holmes) ($1 = 0.6090 pound)