Lord Lawson said he also believed there is a case for paying no bonuses at RBS this year, given the continued fallout from the LIBOR scandal.
The bank is expected to pay a fine running into the hundreds of millions for its role in the affair.
Speaking to the Financial Times, Lawson said RBS, currently 82% owned by the state, should be fully nationalised and turned into a lending vehicle to small businesses.
Lawson, who was Chancellor from 1983 to 1989, called on the government to withstand bank lobbying efforts to water down the proposed ring-fencing of retail assets.
He also criticised the previous Labour government's decision to appoint Stephen Hester as RBS chief executive.
"It is absurd to put a lifetime investment banker in charge of an entity which is overwhelmingly a retail and SME [small and medium enterprise] type bank," he told the paper.
Prudential head of business development Vince Smith-Hughes discusses the consequences of pensions freedom and changes to death benefits