Lessons to learn from the Co-operative Bank crisis

An independent review has examined the problems at the Co-operative Group and Bank over the past few years, which led to a £2.5bn loss reported by the Group.

As published in the Sir Christopher Kelly report, here is a summary of the lessons to learn from the crisis that created a capital shortfall at the Bank and led to the Group losing a 70% stake in the business.

1. Running a full-service bank, even a small one, in a regulated environment is a complex business. In pursuing its ambitions the Bank failed to understand the limits of its own capability.

“The Bank ignored the limitations imposed by its size, its talent pool and, arguably, its location,” says Sir Christopher. “A bank, like other businesses, should focus on areas in which it has competence, only pursuing business and allowing complexity when it is confident that it possesses, or can acquire, the capability to deal with it. However attractive individual projects may be on a stand-alone basis, attempting to pursue too many at the same time can risk failure of all.”

2. The most important task for any board is to put in place the right Executive leadership for the business. The Bank failed to do so.

The Co-operative Banking Group board appointed Neville Richardson as chief executive, but he had “no previous experience of a senior leadership role in a bank.” Some interviewees claimed the board had no choice and that it appears to have been a condition of the merger. Sir Christopher said: “Boards need to be prepared to take hard decisions when circumstances warrant it.”

3. Ownership of a regulated bank by a non-bank requires a clearly articulated statement addressing in sufficient detail the management and governance relationship between the Co-operative Group and Bank. The Group and Bank Boards failed to put one in place.

Said Sir Christopher: “A lack of clarity about the appropriate relationship between Group and Bank allowed a situation which was both too tight and too loose. It was too tight in that the Group Executive was allowed to involve itself too closely through aspects of Project Unity, and to some extent Verde, in matters which ought to have been the preserve of the Bank. It was too loose in that the Group failed to exercise sufficient oversight of the Bank in areas where it had a legitimate interest, like overall strategy.”

4. Failures in board oversight are inevitable if the criteria used to elect its members do not require those elected to have the necessary skills. The Group Board lacked the skills and expertise to oversee the Group’s complex portfolio of businesses effectively.

“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.”

5. To be effective, a bank board must include sufficient numbers of technically competent Directors. At no point before June 2013 did the Bank have this, which helps to explain some of the failures of oversight.

The CBG Board included a number of non-executive directors with banking or insurance experience throughout the period under review, according to Sir Christopher. The other non-executives took considerable comfort from their presence. But those with banking experience did not form a majority before June 2013. Sir Christopher said: “I have no doubt that, had the Board been chaired by an experienced banker of the kind now in place, the challenge and oversight provided to the Bank Executive would have had a much greater chance of forestalling or mitigating some of the problems the Bank faced.”

6. To exercise appropriate supervision and challenge, boards need to be supplied with good management information, and to demand it if it is not forthcoming. Failure to obtain such information explains some of the failings in oversight at both Group and Bank.

Directors would have had a greater chance of providing effective oversight if their executives had provided them with better information, according to Sir Christopher. But he added: “This does not excuse either Board. Effective board members should have the ability to identify the information they need and the forcefulness to ask for it when not provided.”

7. It is fundamental that a bank should develop and implement robust risk governance and oversight and an appropriate control framework. The Bank failed to take timely and robust action to address serious deficiencies in these areas.

Sir Christopher said: “A more rigorous approach to risk management might have prompted greater scrutiny of the due diligence on Britannia, improved the subsequent management of the commercial loan book and led to more rigorous interrogation of the replatforming programme.”

8. Before launching a significant IT transformation project, any institution is well-advised to test whether more modest alternatives will suffice. If it decides to go ahead, it must strive to keep the programme as simple as possible, phase delivery in a manageable way, deploy the right resources, plan for contingencies, and treat the programme as a business priority. The Bank failed in all these areas.

“Most banks have elderly legacy systems,” said Sir Christopher. “Few have attempted total replatforming. Only a handful has done so successfully. None had succeeded in the UK at the time the Co-operative Bank attempted it. The Bank’s ambition to leap ahead of its competitors was commendable. But it was always an unlikely candidate for such endeavour. Success would have required strict compliance with best practice. What happened instead provides a case study of how not to go about it.”

9. Financial institutions ignore regulatory signals at their peril. The Bank should have paid closer attention and responded with greater urgency to what the Regulator told it.

“The Group executive and the Group board, perhaps not surprisingly in view of its composition,” said Sir Christopher, “appear to have had a limited appreciation of the nature of a bank’s relationship with its regulator.”

10. Institutions should pay careful attention to the advice of their external advisers. The Group and Bank ignored well-founded, if inconvenient advice. This proved costly.

“There is little sense in appointing external advisers if the institution consistently ignores or underplays serious concerns and criticisms,” said Sir Christopher.

11. Postponing dealing with problems is almost never a sustainable solution. The Bank consistently eased short-term difficulties by pushing problems into the future.

Sir Christopher said: “Too much emphasis on the short-term creates a risk of focusing only on those areas which appear to be critical at the time. Effective organisations put in place processes which improve the likelihood of anticipating problems. For a bank, the chances of avoiding constant crisis management are greatly increased by monitoring and managing potential issues before they become problematic. The Co-operative Bank gave little appearance of managing risk proactively. It seemed permanently to be in crisis mode.”

12. If an organisation’s values and sense of purpose are to affect the way staff act, they need to be translated into meaningful guidance. The Bank’s ethical positioning should be made much more apparent in a way which influences employee behaviour and means something to customers.

“Some aspects of what is distinctive about the Co-operative Bank’s ethical approach are clear,” said Sir Christopher. “Other aspects are surprisingly less clear. Ethical principles did not, for example, protect the retail side of the Bank from its share of mis-selling payment protection insurance or, it appears from recent announcements by the Bank, from other examples of not treating customers fairly.”

13. Effective strategies address tangible issues of competitive advantage and disadvantage. Mantras about scale and ethics are no substitute for strategies grounded in a real understanding of competitive position, market economics, and organisational capabilities. The Bank lacked such a strategy.

Sir Christopher said: “In the absence of a coherent strategy, the Bank embarked on a journey in search of scale which it proved ill-equipped to pursue, while at the same time choosing to compete across the gamut of retail banking and commercial lending.

“A more thoughtful and considered approach might have helped it think twice about the Britannia merger until market conditions improved, be more proactive about managing down the acquired assets which were outside its risk appetite, and resist the temptation of acquiring the Verde assets at what appeared to be a knock-down price.”

14. Talent management is critical in any organisation. The Bank’s failings owe much to its lack of capability in important areas, driven significantly by weaknesses in its recruitment and subsequent management of talent.

“The Bank struggled to identify and recruit top talent,” said Sir Christopher. “It entrusted the enlarged and more complex institution created by the Britannia merger to individuals whose experience was more closely attuned to running a smaller institution.”

15. Tolerating – as the Bank did – a culture of underperformance, weak transparency and a lack of accountability, constrains an organisation’s ability to respond quickly and robustly to any challenges it faces.

“In the Bank, the culture did too little to discourage the wrong behaviours or to focus attention on areas of highest risk,” according to Sir Christopher, “encourage staff to speak up about potential issues, work collaboratively with the Regulator, or address issues as soon as they became apparent.”