Governance and management failings led to Co-operative Bank’s £1.5bn capital hole

Failings in management and governance led to the capital shortfall of £1.5bn in the Co-operative Bank, according to an independent review. The Sir Christopher Kelly review was commissioned...

Failings in management and governance led to the capital shortfall of £1.5bn in the Co-operative Bank, according to an independent review.

The Sir Christopher Kelly review was commissioned by its then parent organisation, the Co-operative Group in July. Since then the Group’s stake in the Bank has reduced to 30% as it shored up the capital shortfall.

A former senior Treasury civil servant, Sir Christopher said: “The capital shortfall is rooted in a number of specific events. Poor commercial lending, a failed IT project, and mis-selling of PPI accounted for the bulk of it in numerical terms. But the severity of the problem was magnified by failures of management, lack of capability, a fallible culture and weak governance.”

The report, which cost a total £4.4m to produce, describes what happened, identifies the root causes and draws the lessons. It looks at the decision to merge the Co-operative Bank with the Britannia Building Society in 2009, the abortive attempt to replace the Banking Group’s IT platform, the proposed acquisition of the Verde assets from Lloyds Banking Group, and the attempt to bring the Bank closer to the Group under Project Unity.

It also examines the Bank’s management of its loan book, its approach to risk management and capital, its sales of payment protection insurance, the governance of the Bank and the Group and a number of other issues.

“This report tells a sorry story of failings on a number of levels,” said Sir Christopher. “The Bank Executive failed to exercise sufficiently prudent and effective management of capital and risk. The Banking Group Board failed in its oversight of the Executive. The Group Board failed in its duties as shareholder to provide effective stewardship of an important member asset. Collectively, they failed to ensure that the Co-operative Bank consistently lived up to its ethical principles. In all these things they badly let down the Group’s members.”

A number of factors contributed to the debacle of the capital shortfall and the subsequent restructuring, according to the report. These were the economic environment; increasing capital requirements imposed on banks in general following the financial crisis; the merger with the Britannia Building Society in 2009; failure by the Bank after the merger to plan and manage capital adequately; and weaknesses in the governance and management of risk.

Other problems with “material” capability gaps led to a mismatch between aspirations and ability to deliver, the past mis-selling of payment protection insurance (PPI). a “flawed culture” and a system of governance which led to serious failures of oversight.

The report is based on more than 130 interviews with current and former employees, board members and others and on the examination of internal papers and external reports. The review has also received written evidence from a number of individuals and organisations. It has been carried out independently from all other reviews touching on the same events.

In the report, Sir Christopher said: “The Bank ignored the limitations imposed by its size, its talent pool and, arguably, its location.” He said that had management and board understood the extent of their capability then they might have been more inhibited about doubling the Bank’s size through the merger with Britannia and in pursuing the Lloyds Banking Group negotiations, even though it had not then completed the Britannia integration and was simultaneously adding to management stretch through Project Unity.

Following the Britannia merger, he said the board did not put in place the right executive leadership. Neville Richardson had no previous experience of a senior leadership role in a bank and had presided at Britannia over the creation of the high risk portfolio, including the subsequently toxic commercial real estate lending.

Sir Christopher said: “Boards need to be prepared to take hard decisions when circumstances warrant it.”

He also criticised the governance of the Co-operative Group. “Sustained success requires effective governance,” said Sir Christopher. “Effective governance requires a high performing board. The composition of the Co-operative Group Board, and the limited pool from which its members were drawn, made a serious governance failure almost inevitable.”

He added: “The current approach to the election of non-executive directors has conclusively shown itself incapable of producing a Group Board with the necessary governance competences or the business and technical skills required for successful stewardship of the Group’s assets. It promotes activists with concerns about issues important to those who elect them, not individuals with skill sets relevant to overseeing the business. Nor is it realistic to expect these shortcomings to be rectified by training, even if the training is more effectively delivered than appears to have been the case here.”

However, he defended the co-operative model: “My comments on governance should not be interpreted as a criticism of the co-operative model or of co-operative principles and values, for which I have a great deal of respect. It is the particular method of governance adopted by the Co-operative Group and Bank which in my view has manifestly failed, not the co-operative ideal in general. The current governance structure in the Co-operative Group, which dates only from 2001, is not the only way of putting co-operative principles into practice.”

In his report, Sir Christopher concluded: “These lessons have come at a great cost to the Co-operative Bank, its staff, its customers and the members of the Co-operative Group. The failings are very basic. The circumstances which led to them being set out here must pain all who care about the co-operative movement.”

In response to the report, Richard Pennycook, interim chief executive at the Co-operative Group, said: “Following the wake-up call of our recently announced £2.5bn loss, Sir Christopher Kelly‘s report today lays bare the failings of management and governance that caused it. It is a sobering assessment which shows clearly that the Co-operative Group’s loss of control of its Bank could have been avoided.

“The management that instigated this disaster for the Group are no longer in place; the flawed governance structure that failed to apply the right checks and balances, however, remains. Our colleagues, our members and our customers now look to the Group and Regional Boards to deliver the reforms which are so clearly necessary.”

Chair Ursula Lidbetter added: “Sir Christopher Kelly’s report serves as a stark reminder of the scale of change required in the governance of The Co-operative Group – something we have been clear we are already committed to. We thank him for his detailed and thorough work. The Group Board is leading the governance reform process and is putting a resolution containing four key principles to our membership next month.

“The Board awaits with keen interest the Governance Review to be published shortly by Lord Myners. Sir Christopher’s conclusions must strengthen our collective resolve, underlining as they do the urgency of the need for far-reaching fundamental change. We must ensure the mistakes of the past are never again repeated.”

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