WITH REVENUES DECLINGING AND THE REGULATORY COST of doing business rising sharply, investment banks around the world are scaling back and seeking to find the right size and scope for their operations. Few institutions are doing so in the face of as much political scrutiny — and interference — as Royal Bank of Scotland Group.

RBS is the U.K.’s poster child for banking excess. The bank’s breakneck expansion in the past decade — culminating in its ill-fated £48 billion ($76 billion) purchase of ABN Amro in 2007, just before the U.S. subprime mortgage market imploded — left it hopelessly overextended when the financial crisis erupted in full fury after the collapse of Lehman Brothers Holdings the following year. With losses mounting and wholesale funding markets shutting down, RBS needed a massive public capital injection of £45 billion, the largest bank bailout in the world. Not for nothing did CEO Stephen Hester last year describe RBS as “an emblem of the financial crisis.”

Today, Hester is struggling to restore the bank to health while managing the public pressures that come with being 82 percent government-­owned. The former is proving easier than the latter.

Through asset sales and the disposal of noncore businesses, Hester and his team have slashed RBS’s bloated balance sheet by £712 billion, or 44 percent, from its 2008 peak and reduced its reliance on short-term wholesale funding by nearly two thirds, to £102 billion. “We have to defuse the biggest balance-sheet time bomb in history, and we’re making very good progress in doing....