Royal Bank of Scotland today dramatically scrapped the sale of its insurance division, which includes Direct Line and Churchill and had originally been expected to raise the bank up to £7 billion in badly needed capital.

The decision is the first by Government-appointed chief executive Stephen Hester, who took charge at the start of this year. It suggests that he is anxious to avoid any potential fire sales of RBS businesses now that it is majority-owned by the taxpayer.

The insurance division was put on the auction block by former chief executive Sir Fred Goodwin almost a year ago, well before the full extent of the NatWest owner's financial problems emerged and the Government was forced to take a 70% stake in the bank in return for a £20 billion bailout.

Two major private-equity consortia had lined up multibillion-pound bids for the insurance business, which also includes Privilege and Green Flag.

A £4.5 billion offer from a group led by CVC Partners and believed to include Swiss Re was turned down late last year. An alternative bid led by former Aviva UK boss Patrick Snowball and backed by BC Partners and Apollo Management was turned down this week.

Hester said: "Given RBS's broader considerations, it was important to test the market for the business, which has demonstrated that sale on terms currently available would destroy value for RBS's shareholders."

Given that the taxpayer is now a 70% shareholder in RBS, it is clear that the board and its majority owner could not run the risk of being seen to sell off a major financial asset and well-known consumer brand at what could have been a knockdown price.

Hester added: "RBS Insurance benefits from a leading market position, strong cash generation and low capital requirements. It does not absorb funding or risk-weighted assets, and is not closely connected to the credit cycle."

He explained that he now sees the business as a linchpin in his avowed intention to return RBS to strength and ultimately to full private ownership.

"It is an impressive, well-run business with great people and excellent customer franchises," said Hester.

"It can play an important role as we return the RBS Group to standalone strength."

He added that the board had taken the decision after a careful review of the strategic aims of RBS, which it announced at the same time his appointment was made public last November.

RBS Insurance has about 17,000 employees, with almost 15,000 of them in the UK. It increased profits by 41% to £513 million in the first half of 2008.

Snowball, who is reported to have offered to take a majority stake in RBS Insurance rather than buy the business outright, confirmed that he had put in an indicative offer. This was believed to value the business at about £5 billion.

Other potential bidders, who looked at buying the insurance division soon after it was put up for sale but withdrew by last summer, included Warren Buffett's Berkshire Hathaway, Zurich Financial Services and Italy's Generali.