‘Sorry story’: Co-op executives blasted over near-collapse

Sir Christopher Kelly, author of the review, said: “This report tells a sorry story of failings in management and governance on many levels.”

The former Treasury mandarin was asked to investigate after the bank was found to have a £1.5 billion hole in its balance sheet which ultimately required a rescue by bondholders.

His long-awaited report found “overwhelming” evidence that Britannia chief executive Neville Richardson, who took over as boss following the 2009 merger, failed to leave the new business “in a good position” when he departed in 2011.

It also said the culture of the bank was partly to blame, with a “willingness to accept poor performance” and a “tendency not to welcome challenge”.

The board of the wider Co-operative Group, led at the time by Peter Marks, also came in for criticism for failing properly to oversee the bank and badly letting down the group’s millions of members.

Sir Christopher said: “The roots of the shortfall lie in a merger between the bank and the Britannia building society which should probably never have happened.

“Both organisations had problems. Bringing them together exacerbated those problems. It might have worked if the merged organisation had first class leadership. Sadly it did not.”

In response to the report, current Co-op Bank chief executive Niall Booker apologised for “past failings” and said it had been “working diligently” to address them.

The bank also revealed it was appointing new auditors, Ernst & Young, ending a 40-year relationship with KPMG amid a regulatory investigation into the Co-op’s past accounts in the years leading up to the end of 2012.

As well as the merger with the Britannia, at the time the UK’s second largest building society, the report focused on a disastrous attempt to update the banking group’s IT systems.

An abortive attempt to buy more than 600 branches from Lloyds Banking Group, dubbed Project Verde, was also examined, along with attempts to bring the business closer to the wider Co-op Group in a process called Project Unity.

Sir Christopher scrutinised the bank’s management of its loan book, approach to risk management and capital, as well as its involvement in the payment protection insurance mis-selling scandal that caught up much of the wider sector.

The report was based on more than 130 interviews with current and former employees, board members and others, and examination of internal papers and external reports.

Sir Christopher said: “The Co-operative Bank executive management failed in its oversight of the executive.

“The group board failed in its duty as a shareholder to provide effective stewardship of an important member asset. Collectively they badly let down the group’s members.

“The lessons we set out are far from novel. It does no credit to those involved that they must be learnt again.

“I hope my report will help the group and the bank in their efforts to rebuild organisations of which their members and customers can once again be proud.”

Sir Christopher revealed that the only member or former member of the Co-op group or bank leadership who declined to meet him was disgraced former bank chairman Paul Flowers, whose lack of experience for the job has been widely criticised.

The wider Co-op group welcomed the report, saying it demonstrated the need for change in its own governance, which has faced with stiff resistance from some within the organisation.

The group recently announced record losses of £2.5 billion, largely caused by the bank’s near-collapse.

Interim chief executive Richard Pennycook said of the report: “It is a sobering assessment which shows clearly that the Co-operative Group’s loss of control of its nank 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.”

Group chair Ursula Lidbetter said: “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.”

The report comes hours after a separate announcement by the group of the immediate departure of a board member, Stuart Ramsay, following an investigation about high-level leaks.

Former chief executive Euan Sutherland walked out last month after a leak to a Sunday newspaper about his £3.66 million pay package.

The report pinpointed the timing of a requirement by regulators for the Co-op Bank to increase the amount of capital on its balance sheet - from £1.9 billion to £3.4 billion - as “particularly damaging”.

It came just as the bank was taking major hits from its commercial property loan book and its failed IT project, as well as provisions for the mis-selling of PPI.

The report said: “It was the interaction between an increased requirement and a reduction in the capital available to meet it that led to the bank’s capital shortfall.”

But it cleared regulators - who were asking all banks to increase their capital base in the wake of the financial crisis - of singling out the Co-op, and said it had been making “warning noises” about the issue for some time.

“Had the bank listened more carefully, and responded earlier or more vigorously, the increase in its capital requirement might have been less dramatic.”

The report found that the bank had been aware of some of the risks of the Britannia merger and only performed “cursory” checks on what turned out to be the most risky part of the assets it was requiring - the building society’s commercial loan book.

It wrote down the value of these by £284 million but subsequently the balance sheet hit rose to £802 million - and formed the largest single part of its capital shortfall.

A further £300 million came from the IT fiasco, while a charge over the PPI scandal had reached £269 million by the middle of last year.

He said the group and bank boards “seemed either oblivious to these issues or, if they were aware, failed to take sufficient timely action to mitigate them”.

Sir Christopher added that the Co-op’s involvement in PPI mis-selling was “a disappointing outcome for an avowedly ethical bank”.

His report appeared to back calls for change in the wider Co-op group’s structure, saying that while its control by democratically-elected members was fundamental to its ideal, this could be achieved differently.

He said: “I have no doubt at all that the methods used over the last few years to appoint members to the board of the Co-operative group and its subsidiaries have led to serious failures in relation to oversight and governance of the bank.”

It noted that then-regulator the Financial Services Authority (FSA) failed to object to the appointment of Paul Flowers as the bank’s chairman in 2010 despite him being “an individual who manifestly did not have the appropriate experience”.

But it laid the blame at the feet of the group which gave him the role.

Sir Christopher’s review also pinpointed a failure by the FSA to act on Britannia in the run-up to the merger when it decided to buy back some liabilities and debt securities to generate a one-off gain.

This offset a profit fall, enabling a membership dividend for 2009.

Sir Christopher said that in July 2009 the FSA told Britannia the buy-back scheme showed an “insufficiently robust level of forward capital planning, but did not prevent it from going ahead”.

The report threw a spotlight on the role of Mr Richardson, who it said blamed the deterioration in the commercial loan book after his departure partly on executives being distracted by negotiations over Project Verde - the plan to buy branches from Lloyds.

But Sir Christopher said his departure, along with other former senior Britannia staff, did not lead to a weaker team than before.

“Nor do I think that the bank was in a good position when Neville Richardson left. The evidence that it was not is overwhelming.

“The capital position only looked reasonable because problems had been pushed into the future. The risk management framework was poor.

“The IT replatforming project was floundering, and there was little sign of a coherent strategy towards the non-residential mortgage portfolios inherited from Britannia other than to wait for things to get better.”

Sir Christopher said he had found no evidence of pressure for the Britannia merger to have taken place from Government ministers, the Bank of England or regulators.

Sir Christopher said that then-Treasury minister Mark Hoban had declined to meet him in the light of allegations by Mr Flowers that the Co-op had been under pressure to go ahead with Project Verde.

The report noted that the Government, as a major shareholder in Lloyds, would have wanted to see the sale go through - which was required through EU rules on state aid.

But Sir Christopher said no one he had spoken to had provided “compelling evidence” of pressure “from Government ministers or anyone else” for the transaction to take place while regulators had consistently pointed out difficulties.

“The Co-operative group and bank were capable of making mistakes without any help,” he concluded.

The impact on capital of the failed project was a relatively small £73 million but the indirect effect was “far more significant”, the report found, resulting in a “significant distraction from business as usual”.