Treasury report: Co-op Bank debacle a catalogue of failures

The Treasury select committee has today released its report on Project Verde, the Co-operative Bank’s failed bid to buy 632 Lloyds branches. The failure of Project Verde revealed...

The Treasury select committee has today released its report on Project Verde, the Co-operative Bank’s failed bid to buy 632 Lloyds branches. The failure of Project Verde revealed systemic financial problems within the Co-operative Bank and brought the financial institution to the brink of collapse.

The report – the latest in a line of investigations into what happened at the bank over the last year – focuses specifically on why the Co-operative Bank was able to proceed so far in its bid, when it had a capital hole that threatened the existence of the bank itself, not just the proposed purchase.

Led by Andrew Tyrie, chair of the Treasury select committee, the report took evidence for over six months from individuals involved in Project Verde, including key figures at the Bank and Co-operative Group; Lord Peter Levene, then-chair of the Co-op’s rival bidder NBNK; and the chancellor, George Osbourne.

The report identifies failings and mistakes at a number of levels.

“It is not uncommon for deals to collapse,” says the report. “But in this case it was caused by the near collapse of the Co-operative Bank. Each of the backstops – the bank itself, KPMG as its auditor, and the FSA as its regulator – failed to uncover the bank’s capital shortfall until it was too late.

“Each had a hand in this sorry tale. But by far the biggest responsibility lies with the Co-operative Bank leadership.”

Directors

The report points to inadequate governance at the bank, saying its board, being dominated by members of the Group’s main board, lacked the necessary financial expertise. It also highlights the mistake of a model where the bank’s chief executive reported to the Group’s chief executive rather than to the Co-operative Bank board.

It concluded that the “Co-operative Bank’s governance structure up to the middle of 2013 was entirely inadequate for a bank of any size; it is shocking that it was in place in an institution that came so close to becoming a major new challenger bank.”

The report notes that there were discussions on the Bank and Group boards as to whether to proceed with the bid, but ultimately it went ahead because of the strength of feeling at executive level.

Executive

Of the executive team, the report notes that “Peter Marks, [then] chief executive of the Co-operative Group, was, by numerous accounts, the driving force behind [the] pursuit of Verde.”

Giving evidence to the Treasury select committee, Mr Marks said that even following the merger with Britannia in 2009, “the bank, in our view, was sub-scale. It needed to build scale to compete and survive.”

He added: “Verde represented a great opportunity to achieve that scale, and brought with it significant capital – £1.5bn, I think, was the number; a high quality CEO, Paul Pester, who was appointed, if the deal went ahead, as the new chief executive, and was approved by the [Financial Services Authority]; and a management team to strengthen the Co-op management team.”

The report highlights that there were disagreements between the senior executives involved – Peter Marks; the former head of Britannia and Co-op Bank, Neville Richardson; and the subsequent Bank chief, Barry Tootell among others – who differed on timing, but all ultimately agreed that Verde should go ahead.

Auditors

The Co-operative Bank’s then auditor, KPMG, was also singled out by the report. The main cause of Project Verde’s collapse, it says, was a capital shortfall that left the Co-op Bank unable to buy Lloyds branches. This shortfall in turn revealed further holes in the bank’s finances, caused in part by a costly failed IT project and from ‘impairment losses,’ or losses on lending that it had not fully accounted for.

Andrew Bailey, previously at the Bank of England and now chief executive of the Prudential Regulation Authority (PRA), told the Treasury select committee that the “Co-operative Bank’s approach to recording its impairments in the years running up to 2013 was […] ‘looser’ than the rest of the industry.”The report adds that “this should have been clear to Co-operative Bank’s management – to all those responsible for risk and accounting, including the board, relevant executives and committees. It should also have been apparent to Co-op Bank’s auditor – KPMG – and to the regulator for the period in question, the FSA.

“The Committee is surprised that, in spite of the evidence it has heard, Co-operative Bank’s former auditors, KPMG, maintain that Co-operative Bank was not an outlier in terms of its impairments.”

The report echoes Sir Christopher Kelly who, in his independent review in July, which was commissioned by the Bank’s then parent organisation the Co-operative Group, also pointed to KPMG for failing to fulfil its duties as the Bank’s auditors.

Said the report: “The losses emanating from Britannia stemmed predominantly from its commercial loan book. The due diligence performed on this book has proved to have been totally inadequate. KPMG’s initial due diligence was based on incomplete information. Further due diligence, which KPMG recommended be performed, was carried out by Co-op Bank itself.

“The committee is surprised that the additional due diligence—a crucial piece of work—was allowed to be performed to such a low standard. KPMG should have given clear guidance to Co-op Bank about the standard required. The committee is also surprised that, despite recommending the additional due diligence, KPMG did not scrutinise it once complete.”

Regulators

Failings by what was then the Financial Standards Authority (FSA) were also identified by the Treasury select committee’s report. The FSA had a responsibility to regulate the Bank and oversee Project Verde. While the FSA was right to let the sale proceed based on the knowledge it had, says the report, it questions whether the FSA had done enough to investigate whether the Bank had the capital in place to proceed with the sale.

“The PRA – the FSA’s successor body as prudential regulator – admits that, with better supervisory tools, Co-operative Bank’s problems would have been uncovered by the FSA sooner,” reads the report.

 

Despite the length of the investigation, Andrew Tyrie suggests there is more work to be done to discover whether the Bank’s capital hole should have been spotted earlier in the process.

However, the report rejected the suggestion that the Verde deal was subject to political interference – an allegation forwarded by Lord Levene chair of rival bidder, NBNK. Mr Tyrie said that this allegation “was rejected by every other witness who appeared before the Committee. The decision by Lloyds to select Co-op’s bid over NBNK’s is explicable on straightforward commercial grounds.

“In any case, it seems improbable that any such political interference could have been concealed by so many people and for so long. The government publicly stated its support for the Co-operative Bank’s bid, but the Committee has not seen anything to suggest that this constituted improper pressure or bad faith on anyone’s part.”

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