Long-awaited Co-Op Bank report reveals regulatory failures

In 2013, George Osborne ordered a review into failures at Co-Op Bank which began in 2009 when it merged with Britannia Building Society and ended with a near collapse in 2013 when it attempted to purchase 632 bank branches from Lloyds Banking Group.

The Prudential Regulation Authority discovered a £1.5bn shortfall in Co-Op's finances and the Bank was later rescued by a US hedge fund group.

The review concluded that the approach taken by the FSA (now the FCA) left the Co-Op Bank "relatively defenceless" and said that in hindsight, Co-op Bank’s due diligence work should have been challenged.

The independent review by Mark Zelmer includes eight recommendations addressed to the PRA as the institution with responsibility for the supervision of Co-op during the period.

Zelmer acknowledged that the FSA was "busy fighting many fires and overhauling its supervisory practices" as the events surrounding the Co-op Bank began to unfold in late 2008 and early 2009.

However he says the broad remit of the FSA at the time may have diverted their focus away from "acute issues" regarding the adequacy of the bank’s loan loss provisions and the fragility of its capital position.

The review found that the FSA approved Co-Op Bank's merger with Britannia despite "knowing there would be vulnerabilities in the merged bank balance sheet and that there was a risk that the bank would need more capital in coming years".

Zelmer said: "Despite being cognisant of the weak performance of the corporate loan book, I consider that the FSA’s supervisors did not pay enough attention to the refinancing risk that existed in that book and, in line with standards at the time, the adequacy of loan loss provisions in the period following the merger."

The report concluded that there "should have been a greater and earlier focus by the FSA on reviewing the quality of the loan book and its valuation and ensuring adequate capital was in place to cover potential losses".

However Zemler said the FSA "had to form a view on the Co-op Bank/Britannia merger in the context of unprecedented conditions that prevailed in the UK financial system".

He believes that the merger was approved to "contain the potential risk of a major loss of confidence in the building society sector that it judged might emerge in the event that Britannia failed".

In response, the PRA commented: "The PRA and the Bank welcome the Report, which acknowledges the significant changes to prudential regulation that have taken place since the financial crisis, and notes the very challenging environment in which the FSA operated during this time."

The PRA also noted a number of measures which have been introduced since 2013, including statutory safeguards and the introduction of a resolution liquidity framework.

FCA Chair, Charles Randell, added: "We note Mr Zelmer’s findings and join the PRA and HM Treasury in thanking Mr Zelmer for his comprehensive and efficient approach to conducting this review.

"The approach to regulation has significantly changed since the period covered by this review, not least with the move to two separate regulators. Mark Zelmer’s report relates to the prudential supervision of banks now performed by the PRA. The FCA will reflect on the findings and recommendations where relevant."