Royal Bank of Scotland (RBS) has reported a loss of £1.13bn for 2010, a bigger figure than analysts had been expecting.
However, this is an improvement on the £3.6bn loss the bank made in 2009, and the £24.3bn loss it made in 2008.
Money put aside for bad loans fell by 33% compared with a year earlier, to £9.3bn.
The government still owns an 83% stake in RBS after bailing the bank out during the financial crisis of 2008.
Last week, Barclays bank - which received no direct government funding - reported profits of £6.1bn for 2010.
The majority of the loss incurred in 2010 was due to a net exceptional charge of £1.1bn related to the government's Asset Protection Scheme, designed to insure banks against losses from bad loans.
The bank also highlighted a growing problem at its Ulster Bank subsidiary in Northern Ireland.
Nearly £1.2bn of losses on bad loans, mainly to commercial and residential property borrowers, led the bank's losses to more than double to £761m for the year.
For the final three months of 2010, RBS made a profit of £12m, compared with a loss of £765m in the final quarter of 2009.
It lent £52bn to businesses between March 2010 and February 2011, "well ahead" of its full-year target of £50bn, the bank said.
Over the same 11-month period, it lent £15bn to mortgage customers compared with a full-year target of £8bn.
The bank described 2010 as a "step change in our financial performance".
"The return to operating profit reflects both the internal rebuilding process at RBS and the external recovery in market and economic conditions," said chairman Philip Hampton.
"We are still a good way from where we want to be in terms of our performance but 2010 represents another big stride towards that goal."
A number of analysts had expected the bank to break even for the year.
"RBS is clearly making progress from its former woes but remains a group in the grip of transition," said Richard Hunter at Hargreaves Lansdown.
"Bad loan provisions were significantly lower than the comparative period, whilst at an operating level the bank moved into profit after a torrid couple of financial years."
Shares in RBS fell by 2.4% to 46.2 pence following the results announcement.
Earlier this month, RBS said it would pay its investment bankers bonuses of about £950m for 2010 - down from £1.3bn the previous year.
Chief executive Stephen Hester will receive a £2.04m bonus - all in shares - with his salary frozen at the 2008 level of £1.2m.
Last year, Mr Hester declined to take his bonus of £1.6m.
RBS bought Dutch bank ABN Amro before the credit crunch in 2007, but the deal was a disaster and was a major factor in forcing the government to bail out the bank to the tune of £45bn.
The government paid an average of 50.2p for each of the 90.6 billion RBS shares it bought to save the bank from collapse.
The government has said it will sell its stake in RBS, but is unlikely to do so until the Independent Commission on Banking reports its findings.
The head of the commission, Sir John Vickers, will give an update on his findings next month before publishing the final report in September.