LONDON (Reuters) - State-backed Royal Bank of Scotland (>> Royal Bank of Scotland Group plc) intends to sell up to $2.2 billion (1.41 billion pounds) shares in U.S. bank Citizens (>> Citizens Financial Group Inc), which would cut its stake in that business to less than a quarter.

RBS said on Tuesday it would sell 75 million Citizens shares in a public offer, plus an option to sell up to another 11.25 million.

If all the shares are sold that would represent 16 percent of Citizens and reduce RBS's holding to 132.7 million shares, or 24.7 percent.

RBS bought Citizens, based in Providence, Rhode Island, in 1988 and expanded it with 25 acquisitions, including the $10.5 billion purchase of Charter One in 2004.

RBS, 78 percent owned by the British government after being rescued in the 2008 financial crisis, has been reducing its holding in Citizens as part of a retreat to its retail and commercial banking business in Britain.

RBS said it would no longer consolidate its Citizens stake in its accounts following the latest sale. But the bank will have to continue to include the business for regulatory reporting purposes, which will delay a boost to RBS's capital ratios.

RBS should get a boost of about 200-300 basis points to its core capital ratio once Citizens is fully stripped out, industry sources have said. Britain's financial regulator will have to approve when that can happen, potentially whenever RBS sells another tranche of shares.

A capital boost would be valuable to RBS, whose capital could be weakened when it settles claims it misled investors in U.S. mortgage-backed securities.

The bank could have to pay anything between 3 billion and 9 billion pounds to settle the matter, analysts estimate. It has set aside 1.9 billion pounds for a settlement, which could come this year.

RBS sold a first slice of Citizens in an initial public offering in September and sold another chunk of shares in March.

Citizens intends to buy back $250 million of the shares being sold. Its shares closed at $25.94 in New York on Monday, up 21 percent from their IPO sale price of $21.50 and valuing the business at $14 billion.

Morgan Stanley (>> Morgan Stanley) and Goldman Sachs (>> Goldman Sachs Group Inc) are global coordinators and joint book-runners for the sale, and JPMorgan (>> JPMorgan Chase & Co.) and Citigroup (>> Citigroup Inc) are joint book-runners.

(Editing by Louise Heavens and Jane Merriman)

By Steve Slater