Co-op Bank review questions if regulatory reforms go far enough

A long-awaited probe into the near-collapse of the Co-operative Bank has found a number of regulatory failings in the “sorry saga” and warned reforms may not be enough to avoid bank bailouts in the future.

The report by former Canadian central banker Mark Zelmer – which was first commissioned more than five years ago – has concluded that regulatory oversight was lacking in a number of areas in the run up to the Co-op Bank’s dramatic near-failure in 2013.

While many of these issues have already been addressed by regulators in recent years, Mr Zelmer revealed that supervisors at the then Financial Services Authority (FSA) did not thoroughly assess all risks of the Co-op Bank’s loan book.

He also warned that supervisory staff were – and are still – not given enough internal guidance on assessing risks of regulated firms and raised fears over the increasing threat of bank runs on smaller players in the future.

The independent review – which cost £1.8 million to produce – was first commissioned by former chancellor George Osborne in late 2013, but detailed terms of reference were only outlined just over a year ago by City minister John Glen.

It looks at the way the Co-op Bank was regulated at the time of its ill-fated merger with Britannia Building Society in 2009 through to its aborted deal to snap up more than 630 branches from Lloyds Banking Group four years later.

The lender was brought to the brink of collapse when it was forced to abandon the branch deal in 2013 after regulators uncovered a £1.5 billion black hole in its finances.

A rescue deal in 2017 then saw hedge funds seize control of the lender, effectively severing its historic relationship with the wider Co-operative Group.

Mr Zelmer said regulators could have tackled the bank’s loan impairment issues sooner, which may have flagged up issues before the sharp increase in provisions and the emergence of the capital shortfall at the end of 2012.

He said: “I firmly believe 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.”

He also revealed he was “struck by how little internal guidance is provided by the PRA to help its supervisors assess risks within regulated institutions”.

And he alerted over the ever-present risks in the sector, in particular for smaller institutions.

He said “runs on deposits can happen fast in a digital world” and the risks of this may grow with so-called Open Banking, designed to boost competition between players.

He questioned whether reformed regulations – particularly tools to manage bank failures without resorting to a taxpayer bailout – are “sufficient” in the face of these threats.

Despite highlighting a number of regulatory issues, Mr Zelmer said: “Much has changed in the intervening years and I am satisfied that most of the issues that arose with respect to the oversight of the Co-op Bank during the review period have been addressed.”

He said if the Britannia deal was taking place today, it would be subject to a “more thorough prudential appraisal”.

Sam Woods, deputy governor at the Bank of England and chief executive of the Prudential Regulation Authority (PRA), welcomed the review’s findings are said: “We will make sure that we use the lessons from this case to strengthen our approach to prudential supervision.”

Mr Glen added the findings and recommendations “will play an important role in ensuring the UK continues to have a well-regulated and effective financial services sector”.

The report comes a year after Paul Flowers, the Co-op Bank’s disgraced former chairman, was banned from the financial services industry by the Financial Conduct Authority.