During a speech at Glasgow University, Stephen Hester said that allowing banks to collapse is important for a functioning financial system to work effectively.
If this âsafety netâ was in place, then firms could be encouraged to indulge in excessive risk taking when making investments, the banking chief explained.
Despite RBS relying on fiscal stimulus to survive the global credit crisis, Mr Hester said that this should not happen if another crisis occurs in the future.
The banking CEO said: âIt is important to the proper functioning of the market that we do not remove the possibility of failure."
"That would embed entirely the wrong incentives around risk-taking. The next, and in many ways the most difficult step (in the process of reform], then, is to ensure that banks can fail.â
Meanwhile, unnamed sources have claimed that RBS is looking to sell mental health clinic, the Priory.
According to the Wall Street Journal, the bank acquired the business when it took over ABN Amro in 2007.
By Jim Ottewill