Regulator left Co-operative Bank ‘defenceless’ by regulator in Britannia merger, long-awaited report finds

The Co-operative Bank was left “relatively defenceless” by the City watchdog in its merger with Britannia, a report into the bank’s near-collapse in 2013 has found.

An independent review into the now-defunct Financial Services Authority’s (FSA) supervision of the bank in the five years leading up to the crisis has finally been published today.

Read more: Co-op Bank returns to operating profit for first time in five years

A scrapped attempt to buy 623 branches from Lloyds six years ago revealed a £1.5bn black hole in Co-operative Bank’s finances – which came from large losses on commercial property and bad loans acquired from its takeover of Britannia Building Society in 2009.

Five US hedge funds agreed a £700m rescue plan for the bank in 2017 and it finally returned to operating profit last year.

The long-awaited report, by former Canadian central banker Mark Zelmer, found that the regulator approved the merger knowing there would be “vulnerabilities” in the merger bank’s balance sheet.

It said that, in the wake of the financial crisis, the FSA was keen for the merger to go ahead and feared Britannia’s potential failure would damage the “fragile confidence” of the building society sector.

“If the Co-op Bank had walked away from the merger, this would have been seen as a stark, public statement about the condition of Britannia.

“The approach taken by the FSA towards the merger, including its insistence on narrowing the scope of the clauses in the transaction that limited the Co-op Bank’s ability to walk away from the transaction before it formally closed, left the Co-op Bank relatively defenceless,” Zelmer said his report.

He added that if the FSA had challenged Co-op’s due diligence work, it may have highlighted management’s lack of risk management expertise and broader governance weakness.

Zelmer also warned that "runs on deposits can happen fast in a digital world" and feared risks may grow due to Open Banking.

The report found that the issues raised would be effectively dealt with today by the FSA’s successor the Prudential Regulation Authority (PRA), but recommended more thorough internal guidance in assessing risks to financial institutions.

Previous investigations have highlighted a string of management failings at the bank.

Last year the Financial Conduct Authority (FCA) banned former Co-operative Bank chairman Paul Flowers from the financial services industry following a drugs scandal.

Read more: Co-operative Bank reports £87m loss

The bank’s former chief executive Barry Tootell has been banned and fined by both the PRA and the audit regulator the Financial Reporting Council.

PRA chief executive Sam Woods said: “There are always valuable lessons to be learned in these circumstances, and we will make sure that we use the lessons from this case to strengthen our approach to prudential supervision.”