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Co-op Bank left 'defenceless' by regulator in ill-fated merger

The Co-operative Bank was left “defenceless” by the City regulator as it nodded through its ill-fated takeover of a rival four years before its near-collapse, a Treasury-commissioned report has found.

It said the Financial Services Authority (FSA) had identified “vulnerabilities” before it approved the Co-op’s merger with the Britannia building society in 2009.

But the regulator was keen to back the deal partly because of the risks posed to the financial sector had the Britannia failed, and saw the Co-op as the “best available safe harbour”, the report found.

Four years later in 2013, the lender nearly collapsed after discovering a £1.5bn hole in its finances that had to be plugged by a group of US hedge funds and the wider Co-op group.

An inquiry into the crisis was commissioned by then-Chancellor George Osborne and overseen by Mark Zelmer, a former official at Canada’s central bank and the International Monetary Fund.

Mr Zelmer’s long-awaited findings – following previous reports into the episode by Sir Christopher Kelly and Lord Myners – were delivered on Wednesday, as first reported by Sky News.

They address the role played by regulators in what Mr Zelmer called “this sorry saga” – identifying a series of failings and also warning that reforms since then may not be enough to avoid bank bail-outs in the future.

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His report found that a “significant level” of potential weaknesses was discovered when the FSA carried out stress tests ahead of the Co-op’s Britannia deal.

Paul Flowers
Image: Former Co-op Bank chairman Paul Flowers was last year banned from the financial services industry

He added: “The FSA approved the merger in 2009 knowing that there would be vulnerabilities in the merged bank’s balance sheet and that there was a risk that the bank would need more capital in coming years.”

The deal was nodded through by the FSA “in the context of unprecedented conditions that prevailed in the UK financial system”, he said.

“It mainly approved the merger to contain the risk of a major loss of confidence on the UK financial system,” the report added.

Mr Zelmer said if the Co-op bank had walked away from the merger it “would have been seen as a stark, public statement about the condition of Britannia”.

He added: “The approach taken by the FSA towards the merger…. left the Co-op Bank relatively defenceless.”

Mr Zelmer said if the FSA had challenged the Co-op over its own due diligence assessment ahead of the Britannia deal, that “might have been helpful” to the lender which was lacking in expertise and suffering “broader governance weaknesses” at the time.

The FSA has since been replaced in a regulatory shake-up with its functions taken over by the Financial Conduct Authority (FCA) and the Prudential Regulatory Authority (PRA), the latter an arm of the Bank of England.

Mr Zelmer acknowledged that the way mergers such as the Co-op-Britannia deal are handled by regulators has changed over the last ten years.

But a series of recommendations from his report included suggesting more guidance for regulators in assessing risks in such deals.

PRA chief executive Sam Woods said: “We will make sure that we use the lessons from this case to strengthen our approach to prudential supervision.”

The report comes a year after Paul Flowers, the Co-op Bank’s disgraced former chairman – dubbed the Crystal Methodist – was banned from the financial services industry by the FCA.

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