LONDON (Bloomberg) - Billionaire Richard Branson's Virgin Group Ltd. submitted a reduced £1.25 billion ($2.5 billion) plan to take over Northern Rock plc. after Luqman Arnold's Olivant Advisers Ltd. dropped out of the contest.

Virgin and its backers would invest £500 million in Northern Rock and raise another £500 million in a share sale, London-based Virgin said in a statement yesterday. Virgin plans to fold its banking unit, which it values at £250 million, into Northern Rock and rename the company Virgin Bank. Its previous offer for Northern Rock was £1.55 billion.

"We have made a proposal that seeks to stabilise the company and rebuild it as a trusted and thriving institution under the Virgin brand with a long-term future," Virgin Bank Chairman Brian Pitman said in the statement.

Virgin would use a refinancing plan proposed by Goldman Sachs Group Inc. to sell bonds backed by Northern Rock assets and guaranteed by the UK government. The proceeds would be used to repay the estimated £24 billion that Northern Rock borrowed from the Bank of England after credit-market turmoil choked off funding and led to the first UK bank run in more than a century.

The British government, the Financial Services Authority and the central bank will decide whether to submit one of the private proposals for European Union approval by March 17. The bank will be "temporarily" nationalised in the event that the private bids are inadequate, Prime Minister Gordon Brown said last month.

Northern Rock fell 8.3 percent to 88 pence in an extended closing auction in London, valuing the company at £370 million. The shares gained as much as 12 percent earlier yesterday.

Northern Rock's management also submitted a proposal to buy the bank. The plan would raise at least £500 million by selling new shares and reduce the company's assets. The proposal also would use the Goldman plan to pay down the central bank debt and the business would be headed by former Resolution plc. CEO Paul Thompson, the company said.

RAB Capital plc., which owns 7.7 percent of Northern Rock, said it supports the management plan. "We've always said we wanted to see a strong and independent solution for Northern Rock, and there is only one strong and independent solution, which is the management proposal led by Paul Thompson," said a spokesman.

Olivant dropped out of the bidding for Northern Rock because it could not satisfy the government's funding requirements while making payouts to existing shareholders, it said.

"Despite working intensively, we have been unable to formulate a value-creation proposal which meets our investment criteria," London-based Olivant said in a statement yesterday.

Olivant, headed by former UBS AG head Luqman Arnold, earlier said it would invest £150 million in Northern Rock and raise as much as £650 million in a plan to retain its brand name.

Olivant's withdrawal was "bad news for taxpayers," said George Osborne, the opposition Conservative Party lawmaker in charge of Treasury matters. "This means that the government's hand is weakened," he added.

The government funding plan requires Northern Rock's new owners to pay for the bond guarantee, be liable for any defaults on the home loans backing the bonds and bear all the costs of the plan. The government also requested a stake in the new business.

Under Virgin's plan, investors would be able to buy 4.7 new Virgin Bank shares priced at 25 pence apiece for each existing Northern Rock share, it said. Virgin said it will offer the government an equity stake.

Virgin and its backers also would buy shares of the new bank at 25 pence apiece, less than a third of yesterday's closing price for Northern Rock.

Virgin's original proposal, disclosed on November 26, pledged to invest £1.55 billion into the bank, including the Virgin Money unit, £650 million from a rights offer and £650 million from Virgin and backers. They include billionaire Wilbur Ross, American International Group Inc., Toscafund Asset Management LP and First Eastern Investment Group.

"From a Government perspective, Virgin will be the leading prospect," said Ralph Silva, research director at London-based Tower Group in an interview earlier yesterday. "If investors make too much of a huff about this" the company will be nationalised.

Virgin's Branson was among business executives attending a meeting earlier today with Mr. Brown. Northern Rock did not come up at the talks, a routine meeting on the world economy and other issues facing government, Mr. Brown's spokesman Michael Ellam told reporters.

"There was a wide ranging discussion on the state of the world economy, but also climate change and energy security," Mr. Ellam said after the meeting.