Taxpayer-backed Royal Bank of Scotland is pulling out from a government plan that insured its riskiest loans, clearing an important hurdle in its bumpy journey to free itself from state control.

RBS will withdraw from the scheme as the protection is not needed, it said on Wednesday, saving it 125 million pounds each quarter in future fees.

The company was forced to take the insurance as part of a taxpayer rescue that saved the bank from collapse in 2008, which left the government with an 82 percent stake. It needs to show the bank has returned to good health, is less risky and has resolved several technical issues before the stake can realistically be reduced, investors and analysts said.

RBS has paid the minimum required premiums of 2.5 billion pounds ($4 billion) since joining the UK Government's Asset Protection Scheme (APS) in 2009.

The news was widely expected, but welcome. RBS shares were up 2 percent by 1044 GMT, one of the strongest European bank shares.

"This is positive news as it had been rumoured over the summer that the exit might be delayed into 2013," said one of the 10 biggest investors in the bank, who asked not to be named. "There is a small additional positive today in that there are no onerous conditions attached."

The specially designed insurance scheme capped potential losses on 282 billion pounds of RBS's most toxic assets after its bailout in 2008.

"The Government's strategy remains to return RBS to the private sector when it is value for the taxpayer to do so. Today is a step in that direction," said finance minister George Osborne.

The government is sitting on a 20 billion pound loss on the 45 million pounds of capital it pumped into RBS. It could sell a first stake at a loss, but there are several more milestones to pass before that is likely.

"My betting is first placement prior to next election but it's a fluid situation," the institutional investor said.

BUMPS IN ROAD

RBS needs to complete a complex capital restructuring, parts of which require approval from European regulators. It would involve getting rid of a dividend access share - which gives the government the right to an enhanced dividend payout and could cost the bank about 1.8 billion pounds - and converting the government's B shares into ordinary shares.

The bank could also look to sell its U.S. business Citizens, and use the proceeds to buy back some of the government's shares, analysts said.

Those steps would improve the government's chances of selling RBS shares, creating a well capitalised bank with a clear UK focused strategy. That could appeal to a sovereign wealth investor such as Qatar, although the full turnaround is likely to take many more years, analysts said.

The bank continues to hit bumps. It last week successfully sold a first tranche of shares in its insurance arm Direct Line, but days later its 1.65 billion-pound deal to sell 316 bank branches to Spain's Santander collapsed.

It has to restart the sales process and may only get half that amount from a new buyer.

RBS is also under investigation by the U.S. and UK authorities over the Libor interest rate-rigging scandal and possible breaches of U.S. economic sanctions against Iran.

Those issues are threatening to overshadow the turnaround driven by Chief Executive Stephen Hester, who has said there was "about 15 months of heavy lifting still to do" for the recovery.

(Editing by Raji Menon and Hans-Juergen Peters)