Conclusions and recommendations
Bidding for Verde
1. From
the start of the Verde process in 2011, the FSA was sceptical
of Co-op Bank's ability to take the transformational step represented
by the acquisition of the Verde branches. The FSA's concerns spanned
almost every material aspect of Co-op Bank's business: its liquidity
and risk management framework; its integration strategy; its governance
framework; its senior executive management team; and its capital
plan. Co-op Bank took steps to address some of these concerns.
But the FSA remained unsatisfied on a number of points, and even
after Co-op Bank signed Heads of Terms in July 2012, the regulator
expressed disquiet about Co-op's governance, its integration plan,
and its prospective financial soundness. (Paragraph 77)
2. Neville Richardson,
the bank's former Chief Executive, warned at the start of the
process in mid-2011 of the management burden that the Verde transaction
could pose. Co-op Bank's Deputy Chairmen had doubts about the
commercial sense of the transaction: whether Co-op possessed the
necessary resources and competence to compete in banking as well
as other markets, and whether the economic outlook and future
regulatory capital pressures might make the deal less attractive.
Following a significant costing error in the bank's IT replacement
programme, both Deputy Chairmen also began to doubt whether Co-op
Bank was even capable of completing the integration with Verde.
(Paragraph 78)
3. However, it was
not clear at the time that the numerous and varied challenges
facing Co-op Bank's bid were insurmountable. Despite knowing the
FSA's views on the difficulties that Co-op faced, Lloyds chose
to pursue a deal with Co-op Bank, both in the December 2011 and
the June 2012 rounds of bidding. Co-op Bank's Deputy Chairmen,
though they had doubts about the transaction, did not recommend
to the regulator in their exit interviews that the deal be stopped.
Neville Richardson similarly wanted Verde to go ahead, with the
proviso—made clear in the script of his conversation with
Peter Marks and others in July 2011—that other projects
should be implemented more slowly. Notwithstanding its own deep
misgivings, the FSA did not instruct Co-op to call off its pursuit
of Verde. Instead, it afforded the bank the opportunity to address
its concerns. (Paragraph 79)
4. By setting out
strict conditions that Co-op Bank would need to meet for the deal
to go ahead, the FSA permitted Co-op Bank to take its own commercial
decision without the regulator's statutory objectives for financial
stability and consumer protection being put at risk. While there
remained any reasonable prospect that Co-op Bank might be able
to meet these conditions, it was appropriate for the FSA to allow
the deal to progress. (Paragraph 80)
5. The evidence that
the Committee has heard does not, however, give cause for great
confidence that the management of Co-op Bank in place throughout
the bidding process would ultimately have satisfied the regulatory
hurdles for Verde to go ahead. It is doubtful that this management
team—which had not been successful in completing the integration
with Britannia—could have convinced the regulator of its
ability to integrate Verde. Furthermore, the regulator's warnings
about Verde, while clearly intended to be forthright, do not seem
to have been properly understood by Co-op Bank: Sir Christopher
Kelly concluded that the bank did not interpret the FSA's concerns
as "the warnings they were undoubtedly intended to be".
Peter Marks, group Chief Executive, erroneously described the
FSA's concerns to the Committee as things that Verde could have
solved, rather than things that Co-op would need to have addressed
before Verde could go ahead. It would have been crucial for Co-op
Bank to have met the regulator's demand for a "permanent
and suitable management team", were Verde to have proceeded.
(Paragraph 81)
The financial collapse of the Co-operative Bank
6. A
very significant factor in Co-op Bank's financial collapse was
the emergence of substantial impairments on loans over 2012 and
2013, primarily in its commercial real estate book. The majority
of these loan impairments—around £550 million—relate
to assets acquired through the Britannia merger. Impairments of
well over £400 million have also arisen on assets originated
by Co-op Bank itself. (Paragraph 124)
7. Attempts have been
made to paint Co-op Bank's impairment losses as the result of
a shift in the regulatory goalposts. The Committee does not agree.
The PRA's capital exercise applied to a number of banks, and only
Co-op Bank was so badly affected. Co-op Bank's impairment losses
were primarily the result of its own, and Britannia's own, poor-quality
lending. The late emergence of these losses appears to have been
due to Co-op Bank's comparatively "loose" approach to
recording impairments, which was uncovered only once the FSA began
its capital exercise in late 2012. (Paragraph 125)
8. Co-op Bank's approach
to recording its impairments in the years running up to 2013 was
described by Andrew Bailey as "looser" than the rest
of the industry. This should have been clear to Co-op 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. (Paragraph 126)
9. The Committee is
surprised that, in spite of the evidence it has heard, Co-op Bank's
former auditors, KPMG, maintain that Co-op Bank was not an outlier
in terms of its impairments. The FRC's inquiry into the approval
and audit of Co-op Bank's financial statements should determine
precisely how Co-op Bank's approach to recording impairments differed
to that of other banks, and why KPMG apparently failed to uncover
this. The independent inquiry into events at Co-op Bank should
also look closely at the shortcomings of the bank's auditor, KPMG,
and its apparent failure to ascertain the extent of the impairments.
In so doing, the inquiry should look to see if any shortcomings
are unique to the KPMG relationship with Co-op. (Paragraph 127)
10. The PRA—the
FSA's successor body as prudential regulator—admits that,
with better supervisory tools, Co-op Bank's problems would have
been uncovered by the FSA sooner. It was the development of these
tools—as part of the transition to the new approach to regulation
in which the FSA and now the PRA have been engaged—that
led to Co-op Bank's impairment losses being revealed. The independent
inquiry into the events at Co-op Bank should consider whether
the FSA could or should have developed better supervisory tools
earlier, and hence uncovered Co-op Bank's impairments sooner.
The inquiry should also consider whether Co-op Bank's impairment
profile—which appears to have differed from that of other
banks throughout the financial crisis—should have led the
regulator to inspect it more closely prior to 2012. (Paragraph
128)
11. Notwithstanding
any shortcomings in the respective oversight roles played by the
auditor and the regulator that may be uncovered by the other inquiries,
banks—in this case the Co-op Bank—bear primary responsibility
for their own prudent management. (Paragraph 129)
12. 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. Co-op Bank's
work has been described by Sir Christopher Kelly as "cursory"
and "limited". The provisions against future losses,
made on the basis of the due diligence, were far too low. (Paragraph
130)
13. 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. If KPMG considered it outside its
remit to examine Co-op Bank's own due diligence, it could still
have given particular attention to the inherited Britannia assets
in future annual audits; the FRC investigation should examine
whether or not KPMG did so. (Paragraph 131)
14. Given the evidence
it has heard, the Committee is very surprised by JPMC's statement
to the Co-op Bank board at the time of the merger that the Britannia
due diligence "exceeded that normally undertaken for listed
companies". This is not reassuring about the typical quality
of professional advisory work, particularly given the substantial
sums often involved—KPMG and JPMC received £1.3 million
and £7 million—and the important advice and guidance
they provided on the Britannia transaction. The Committee expects
the independent inquiry into the events at Co-op Bank to examine
whether the work provided by KPMG and JPMC met a reasonable standard,
in substance as well as form. (Paragraph 132)
15. The FSA performed
its own analysis of the Britannia acquisition at the time of the
merger in 2009. This projected that, under stressed conditions,
the combined entity's Core Tier 1 capital ratio could fall to
4.3 percent, marginally above the regulatory minimum of 4 per
cent in place at the time. Co-op Bank's losses up to June 2013
reduced its capital ratio to 4.9 per cent—roughly the level
the FSA had projected. But the capital shortfall revealed by the
PRA reflected not just actual losses, but also the vulnerability
of the Britannia assets to future impairment. It is not clear
that the FSA's analysis on the merger took this additional risk
into account. The independent inquiry into the events at Co-op
Bank should examine why the FSA apparently failed to account for
the prudential risks of the Britannia merger that have since materialised.
(Paragraph 133)
16. Co-op Bank sought
the merger with Britannia in part because of the latter's large
network of branches. But—as was clear from the work of the
external advisors at the time—the merger also brought an
immediate dilution of Co-op members' interests in terms of net
assets, profits and dividends, as well as an exposure to higher-risk
lending and an increased reliance on wholesale funding. Even without
the benefit of hindsight, therefore, it is clear that the merger
with Britannia exposed Co-op Bank to considerable new risks yet
carried comparatively modest benefits. The commercial judgement
behind the decision to proceed with the transaction, made by Co-op
Bank on the basis of advice from JP Morgan Cazenove, appears questionable.
(Paragraph 134)
17. Andrew Bailey
has said that Britannia would have failed had it not merged with
Co-op Bank in 2009. The former management of Britannia rejects
this, saying that the merger was not a rescue. There is no way
to know for certain what would have transpired without the merger,
but the evidence appears to support Mr Bailey's view. In particular,
the impairments of £550 million now evident from Britannia
would probably have been large enough to bring it down as a standalone
firm, given the size of its Tier 1 capital base at merger and
the capital requirements in place even in 2008. In addition, without
the prospect of the merger, Britannia might well have found it
difficult to fund itself had the problems with its balance sheet
been perceived. (Paragraph 135)
18. Co-op Bank's impairments
are as yet only provisions, and not cash write-offs. The distressed
loans might yet perform better than expected. But impairments
can only be made when there is evidence of a permanent loss of
value—a loss which is expected to be made unless conditions
improve. The possibility of better performance in no way detracts
from the seriousness of the impairments and their effect on the
balance sheet. Statements by the former management of Britannia,
drawing a distinction between impaired lending and cash write-offs,
suggest that they continue to deny the seriousness of the impairments.
They should instead accept responsibility for originating the
distressed assets. (Paragraph 136)
19. Co-op Bank's consumer
redress losses are large and damaging for an institution of its
size. Combined with its other losses, they pushed Co-op Bank to
the brink. Co-op Bank is not alone in having to set aside large
sums to pay for past misconduct. However, such misconduct is particularly
unacceptable in a bank that trades on its ethical character. (Paragraph
141)
20. Co-op Bank's banking
IT system had been in need of replacement for many years. The
prospective acquisition of Verde only made this need more acute.
But the bank, through a combination of over-ambition and poor
management, failed to deliver a replacement. Following over five
years of delays and cost increases, the programme was cancelled,
leaving the bank with its original platform still in place and
a £300 million deduction from its capital. (Paragraph 153)
21. There are signs
that difficulties with the programme were accentuated by the Britannia
merger and the Verde deal. But the evidence suggests that these
deals did not cause the problem: the root cause was a management
team incapable both of delivering the necessary IT transformation
and of realising its own limitations. (Paragraph 154)
22. While it had no
effect on the extent of the write-off, the accounting treatment
that Co-op Bank adopted for the IT programme had a significant
influence on the timing of the impact on the bank's capital position.
One method of accounting—funding the programme directly
through the bank—would have ensured that the costs of the
programme were deducted from Co-op Bank's capital position as
they were incurred. The method adopted—financing the programme
through a service company owned by the bank—meant that the
full cost was recorded over a six month period as the programme
was paused and then cancelled. The FRC should consider as part
of its investigation whether this accounting treatment was appropriate.
The independent inquiry into the events at Co-op Bank should establish
whether this accounting treatment was brought to the attention
of the FSA, and whether the FSA should have foreseen and acted
on its consequences. (Paragraph 155)
23. A combination
of financial losses and increased regulatory capital requirements
together led Co-op Bank to develop a significant capital shortfall.
Co-op Bank's loan impairment losses, IT write-offs and conduct
redress costs caused a serious depletion of its capital resources.
While regulatory adjustments applied to all banks, the increased
capital requirements on Co-op Bank were particularly large. This
reflected weaknesses particular to Co-op Bank—the vulnerability
of its Britannia loanbook to future impairment, high concentration
risk in its corporate lending and a poor operational risk framework.
(Paragraph 166)
24. The collapse in
Co-op Bank's financial position prompted its withdrawal from the
Verde transaction. Explaining its withdrawal from the process
in April 2013, Co-op Bank spoke obliquely of "the impact
of the current economic environment, the worsened outlook for
economic growth and the increasing regulatory requirements on
the financial services sector in general". However, Co-op
Bank's former Chief Executive, Barry Tootell, gave a franker admission:
he told the Committee clearly that he recommended to Co-op Bank's
board, and to group Chief Executive Peter Marks, that Co-op should
not pursue the transaction because it lacked the capital strength
to do so. (Paragraph 167)
25. There is reason
to think that the frailty of Co-op Bank's capital position could
have been discovered sooner—specifically, if the bank had
monitored its loan book and its treatment of customers more effectively,
and if it had accounted for its banking IT programme in a different
way. Had Co-op Bank's resulting capital shortfall been uncovered
earlier, it is likely that the bank would not have progressed
so far with Verde. As it was, the rapid and late emergence of
the capital problem led to Co-op's withdrawal from the Verde process
at a relatively late stage. The Committee recommends in paragraphs
127, 128 and 155 that the FRC investigation and the independent
inquiry into the events at Co-op Bank consider the role of KPMG
and the FSA in relation to the late emergence of loan impairment
and IT losses. On the basis of these findings, the independent
inquiry into the events at Co-op Bank should also form a view
on whether Co-op's Verde bid could or should have been halted
sooner. (Paragraph 168)
26. Once Co-op Bank's
capital shortfall became clear in January 2013, the bank might
have been expected to withdraw immediately from the Verde deal.
The Committee shares Sir Christopher Kelly's surprise that it
did not—instead, Co-op persevered with the deal until late
April. It may be that Co-op Bank had confidence that 'Project
Pennine'—a plan to bolster Co-op Bank's capital position
through disposal of assets—would put it back on a secure
financial footing; if so, this confidence proved to be misplaced.
(Paragraph 169)
27. The board and
management of Britannia are responsible for having originated
the majority of Co-op Bank's distressed assets, as well as assets
against which Co-op Bank has been forced to hold substantial protective
capital. Co-op Bank itself is responsible in a number of other
respects, including its inadequate due diligence on the Britannia
merger. Co-op Bank originated loans which have suffered impairment.
Legacy conduct issues relate predominantly to past actions by
Co-op Bank. Responsibility for the mismanagement of Co-op's banking
IT platform upgrade, while complicated by the Britannia merger,
lies squarely with Co-op Bank. The former board and management
of Co-op Bank and Britannia bear primary responsibility for the
bank's resulting financial crisis. (Paragraph 170)
Governance
28. Co-op
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. Co-op Bank's board was dominated by members
from the parent group who lacked financial services experience.
Those members with financial services experience were responsible
for overseeing a very broad range of business. Being small in
number, their expertise was spread too thinly, and ran the risk
of being over-ruled by possibly well-meaning, but inexperienced,
democratic members of the board. Yet, at least from 2009 to 2011,
the board was also too large and unwieldy to allow for meaningful
discussion and debate. The executive was also subject to influence
from Co-op Group, with the bank's Chief Executive in a direct
reporting line to the group's Chief Executive from 2011. (Paragraph
203)
29. There was a place
for representation of Co-op Group on the bank board. As sole shareholder,
the group's views needed to be heard. But this should not have
come at the expense of the experience necessary to run the bank.
Indeed, in the context of a controlling interest in the bank,
the Group's board structure and inexperience should have been
of more concern to the regulator than it apparently was. (Paragraph
204)
30. The deficient
composition of Co-op Bank's governance was embodied in Paul Flowers,
who lacked any of the requisite financial services experience
to act as Chairman of a bank. In this regard he appointed two
experienced Deputy Chairmen to strengthen the advice to him and
the board. Mr Flowers was appointed on the basis that he would
be able to navigate the 'politics' of Co-op Group and chair the
board. We took evidence that he had performed these functions
well. But this was an inappropriate basis for his appointment.
An effective bank Chairman should usually possess a good deal
of experience of financial services. He or she should be at least
capable of understanding financial issues. Mr Flowers lacked both
the desirable experience and the minimum essential skills. He
should not have put himself forward for the role. Co-op should
not have selected him. The regulator should not have permitted
his appointment. (Paragraph 205)
31. Clive Adamson
and Andrew Bailey have said that an individual with as little
financial experience as Mr Flowers would not be appointed as Chairman
of a bank today. That he was allowed to perform the role at all
is further proof, if it were needed, of the inadequacy of the
Approved Persons Regime. This regime, in principle the means by
which the regulator can ensure that those who run banks have the
requisite expertise, is in practice a narrow box-ticking exercise.
It operates mostly as an initial gateway, providing very little
subsequent oversight of those at the most senior levels in banks.
The new Senior Managers Regime—recommended by the Parliamentary
Commission on Banking Standards, given statutory underpinning
by the Government and now being consulted on by the regulators—seeks
to address these deficiencies. Properly implemented, the regime
provides a better prospect that the most senior individuals will
have sufficient financial expertise to perform their roles effectively,
or at least have the capacity to understand the questions put
before them and to ask some of their own. (Paragraph 206)
32. While the Approved
Persons Regime will be abolished for the banking industry, it
will be retained for many in the remainder of the financial services
industry, including insurance and asset management. Given its
manifest failings, this appears hard to justify. Clive Adamson,
Director of Supervision at the FCA, appeared in oral evidence
to agree with this view. The Government and the regulators should
at the earliest opportunity make proposals to extend the coverage
of the Senior Managers and Certification Regimes to, and remove
the application of the Approved Persons Regime from, other parts
of the financial services industry. (Paragraph 207)
33. Co-op's governance
was not the source of all the bank's problems. The bank was also
hampered by an ineffective executive team. Failures of risk management
within the bank itself are to blame for taking on and obscuring
excessive risk. But defective executive management can only persist
if there is ineffective board oversight. The bank's board was
incapable of providing the necessary guidance and challenge to
the executive. (Paragraph 208)
34. All boards make
mistakes, and take decisions that, in retrospect, they should
not have taken and which may incur large losses. But the previous
governance of Co-op Bank—in its structure and its composition—seems
to have invited the risk of failure, whether in the decision to
merge with Britannia, in the failure to uncover the bank's impairments,
or in the failure to act decisively on the regulator's warnings
about the Verde deal. What's more, the previous management of
Co-op Bank presided over the bank's prudential and conduct failures
while presenting customers with the façade of a prudent
and ethical business. (Paragraph 209)
35. Evidence heard
and seen by the Committee during this inquiry paints a picture
of specific, serious governance failings at the Co-op which contributed
to the losses in the bank. In pointing out these governance failings
the Committee is mindful that other financial institutions with
more conventional PLC boards also collapsed in recent years at
huge cost to the taxpayer. (Paragraph 210)
36. Rodney Baker-Bates
and David Davies, Co-op Bank's two Deputy Chairmen, opted to resign
from the bank's board because they dissented on Verde. In the
circumstances, they took an honourable course. However, board
members should not always feel obliged to resign merely because
they disagree with a major business decision or transaction. Resignation
can deprive a board of valuable skills and experience. But there
may be circumstances in which there is no alternative to resignation.
Such circumstances may include non-executives believing that the
firm's future is endangered by the board's failure to heed their
warnings, or senior board members obstructing constructive criticism.
The FRC should examine whether there is value in providing guidance
in the UK Corporate Governance Code on the circumstances that
might call for a board member to resign, and the factors that
board members should take into account when making their decision.
(Paragraph 211)
37. Peter Marks has
been identified by our witnesses as the driving force behind Co-op's
Verde bid. He appeared to lack any of the financial services experience
that would warrant such a role. He also lacked the necessary regulatory
approval, being approved only as a non-executive yet appearing
to have acted in a de facto executive capacity. Barry Tootell
claims to have had responsibility for the Verde deal as bank Chief
Executive, but other witnesses have described Mr Marks as leading
the negotiations, and were clear that Verde was a group-led project.
(Paragraph 212)
38. The Committee
has heard that Verde would not have gone ahead unless the bank
had approved it. But the group's dominance on the bank board and
the apparently cursory engagement of the experienced board members
on the detailed Verde negotiations made credible dissent unlikely.
Moreover, what disagreement there was—from the bank's two
Deputy Chairmen—appears to have been forgotten or ignored
by Peter Marks, who told the Committee that Verde at all times
had the unanimous support of the bank board. Rodney Baker-Bates
also described Peter Marks, Len Wardle and Paul Flowers as being
"deaf" to objective risk analysis of the deal. This
was scarcely the way for a bank to consider a major acquisition.
(Paragraph 213)
39. Earlier in this
Report, the Committee concluded that the management of Co-op Bank
in place during the Verde bidding process was unlikely to have
been able to address the regulator's concerns about the bid. This
same management, and all those in Co-op Bank's management since
the Britannia merger, bear some responsibility for the manner
in which the deal ultimately collapsed. Co-op Bank should have
come to terms sooner with the risks it was running; having done
so, it might have decided not to pursue Verde. As it was, the
leadership of Co-op Bank proved incapable of appreciating and
addressing the problems in the bank, and the Verde deal was allowed
to continue, driven by the enthusiasm of a small number of Co-op
Group members, until Co-op Bank's capital shortfall finally emerged.
(Paragraph 214)
Was the bidding process fair?
40. Lord
Levene made a number of serious and specific allegations to this
Committee. He alleged that there was political interference to
the public detriment in the Verde deal, and that this constituted
bad faith. He alleged that Lloyds moved the goalposts of the Verde
auction to help ensure that Co-op won, and that this also constituted
bad faith. Lord Levene further asserted that it was not reasonable
for Lloyds to have concluded that Co-op Bank's bid was superior
to NBNK's on commercial grounds. (Paragraph 271)
41. The Committee
concluded that the allegation of political interference was of
sufficient concern to require oral testimony from the Chancellor.
He assured us that the Government brought no undue pressure to
bear on the Verde process. The Committee also heard from António
Horta-Osório and Sir Win Bischoff that the Government applied
no pressure to Lloyds in respect of the Verde deal. Andrew Bailey
told the Committee that the Government had not put the regulator
under any pressure in respect of its primary obligations. Peter
Marks told the Committee that he was not aware of any pressure
being placed on Co-op by the Government to bid for Verde. Robin
Budenberg told us that UKFI had not advised Lloyds of any preference
for Co-op Bank's bid. Sir Nicholas Macpherson said that he was
not aware of any improper behaviour by politicians with respect
to the Verde transaction, and that he would have expected such
behaviour to have been brought to his attention. (Paragraph 272)
42. Lord Levene's
central allegation is of political interference in the Verde process,
to the public detriment. The Committee heard strong and unambiguous
denials from those involved—Lloyds, the regulator, Co-op
and the Treasury. It is difficult to think of an explanation that
would sustain Lord Levene's allegation, other than that all our
witnesses had either suffered a failure of memory or intentionally
misled the Committee. The latter explanation would also require
witnesses to have similarly misled Sir Christopher Kelly, who
found no compelling evidence of political pressure for Verde to
go ahead. Furthermore, for their credibility to be maintained,
it would presumably require witnesses to have taken a decision
to sustain their mendacity during the forthcoming independent
inquiry into the events at Co-op Bank. It would also have required
the board members of Lloyds Banking Group to have neglected their
fiduciary duty to shareholders—by selecting a bidder which,
if Lord Levene's allegation is to be believed, was manifestly
unsuitable in commercial terms—at huge reputational, professional
and personal risk and for no apparent benefit. And it is likely
also to have required the chief legal counsels of Lloyds, the
Treasury and the regulator to have countenanced Lloyds's proceeding
with an inferior bid on the basis of political expediency. The
Committee does not consider all this to be plausible. Nor does
it consider it likely that such serious and far-reaching impropriety
and bad faith as Lord Levene alleges could have been covered up
in several major public and private bodies for over two years
following the conclusion of the bidding process. (Paragraph 273)
43. In his oral evidence
to the Committee, Paul Flowers agreed with other witnesses that
there had been no political pressure in the Verde process. In
response to six further separate questions from the Committee,
he confirmed this view. In a subsequent press interview, however,
he contradicted this evidence, claiming that Co-op Bank had come
under "considerable" pressure from the Government during
the bidding process. Given the flatly contradictory nature of
his evidence, the Committee does not consider Mr Flowers a reliable
witness—on Verde, on the Britannia deal, or on any other
matter—and has not taken his evidence into account in any
of its conclusions. (Paragraph 274)
44. The only relevant
evidence that the Committee has heard claiming that there was
political interference in the Verde deal has come from Lord Levene.
In turn, Lord Levene admitted that the only "hard evidence"
he had of political interference came from a conversation with
the former Governor of the Bank of England, Lord King, in which
Lord King had informed him that Lloyds's Verde decision would
be made on political grounds. Lord Levene told the Committee that
the Governor had called for this meeting, creating the impression
that there was something that the Governor particularly wanted
to communicate to Lord Levene. The Committee has investigated
these allegations. Lord King has told the Committee, however,
that he did not instigate the meeting. Furthermore, Lord King
told the Committee that the concerns he expressed in the meeting
related only to delays in the divestment process, and not to political
involvement in Lloyds's decision. Lord King's recollection of
the meeting is supported by a contemporaneous note of the meeting
produced by a Bank of England official. Lord Levene continues
to dispute Lord King's position, but on the basis of the evidence
that it has taken, the Committee is inclined to accept Lord King's
version of events. (Paragraph 275)
45. The Chancellor
agreed that the Government was pleased to see Lloyds proceed with
Co-op's Verde bid. This was consistent with the Government's stated
policy both to encourage mutual firms and to deliver a challenger
bank of the size proposed by the Independent Commission on Banking.
Witnesses from Co-op Bank claimed that the Government had expressed
its "goodwill" towards the bank's bid. Lloyds agreed
that it was "publicly well known" that the Government
looked favourably on Co-op's bid—a preference made clear
to Lloyds once it had first named Co-op as preferred bidder in
December 2011. The regulator was also aware of the Government's
support for Co-op Bank's bid. The Committee has seen no evidence,
however, that the goodwill expressed by the Government towards
Co-op Bank's bid amounted to pressure on any party. Our witnesses
have presented us with overwhelming evidence to the contrary,
and the Committee therefore rejects Lord Levene's allegation of
political interference in the Verde deal. (Paragraph 276)
46. The Committee
has not had access to the record of the Government's contacts
with Co-op Bank and Group, Lloyds Banking Group, the regulator,
UKFI and NBNK during the bidding process, which the Chancellor
proposes to hand to the independent inquiry into the events at
Co-op Bank. While the Committee is satisfied by the unequivocal
statements it has received from witnesses that there was no political
pressure brought to bear in respect of Verde, the record would
usefully provide a fuller picture of the Government's precise
involvement in the Verde process. (Paragraph 277)
47. The Committee
has considered Lord Levene's allegation that Lloyds 'moved the
goalposts' of the Verde process to ensure a Co-op victory. While
Lloyds did change the bidding process on a number of occasions,
it was reasonable for it to have done so. The changes that were
made appear to have been in the interests of Lloyds's shareholders,
and to have benefited on different occasions both Co-op Bank and
NBNK. Lloyds also changed the package of assets on offer, but
this was in response to requests from both bidders, and was advantageous
to both. The Committee therefore rejects Lord Levene's allegation.
(Paragraph 278)
48. The Committee
has also considered Lord Levene's allegation that Co-op Bank's
Verde bid could not reasonably have been judged superior to NBNK's.
Comparison of the Co-op Bank and NBNK bids was clearly a complicated
and technical matter. Lloyds had to weigh up a number of competing
factors in coming to its decision. Its view of the financial merits
of both bids was based on independent professional advice. It
knew that there were execution risks with both bids—the
regulator had made this clear—and, while Co-op Bank eventually
withdrew from the process following the revelation of the capital
shortfall, this was not reasonably foreseeable at the time of
Lloyds's decision. On the basis of the evidence it has taken,
the Committee rejects Lord Levene's allegation that Lloyds was
unreasonable in judging Co-op Bank's bid to be superior on commercial
grounds at the time of the Verde bidding process. (Paragraph 279)
49. Lord Levene himself
accepted that political interference might not have been the explanation
for Co-op's Verde victory. He told the Committee that a desire
from Lloyds to divest Verde through an Initial Public Offering,
and to secure this outcome by awarding Verde to a Co-op bid that
was likely to collapse, was "probably the real answer".
The Committee does not endorse this view of events. But the Committee
notes that Lord Levene, the only voice alleging specific improper
political involvement in Verde, has concluded that a sufficient
explanation for the outcome of the bidding process could reasonably
be provided by Lloyds's own commercial objectives. (Paragraph
280)
Events following the collapse of Verde and the
emergence of the capital shortfall
50. The
problems at Co-op over the last few years are not an indictment
of the mutual model. The problems of Co-op were, on the whole,
particular to Co-op. Other mutual firms have come through the
financial crisis well. (Paragraph 290)
51. The inability
easily to raise capital is, however, a marked vulnerability in
the mutual model. The PRA now claims to take the particular features
of mutual firms into account as part of its approach to supervision.
This is an important change of approach. (Paragraph 291)
52. One of the most
significant consequences of Co-op Bank's near-collapse, from a
public policy perspective, was the collapse of Lloyds Banking
Group's planned divestment. Co-op Bank's withdrawal forced Lloyds
to resort to its fallback option of an Initial Public Offering.
The result is a new bank—TSB—which, not having an
existing banking presence of its own, consists solely of the business
divested by Lloyds. Accordingly, it has a personal current account
market share not of 7 per cent, but of 4.2 per cent. There is
a risk that a bank of this size might struggle to grow significantly
and to act as a true challenger in the market. This is not a judgement
on TSB or its management, but reflects an observation of the Independent
Commission on Banking that the entity resulting from Verde should
have a market share of at least 6 per cent to have the best chance
of becoming an effective challenger bank. (Paragraph 300)
53. The Verde divestment
alone was never likely to be enough to inject sufficient competition
into the UK banking market, which is the best way of improving
consumer outcomes. The Treasury Committee, repeatedly, and also
the Parliamentary Commission on Banking Standards, have both advocated
measures to increase competition. (Paragraph 301)
54. The Committee
welcomes the news that there has been a substantial recent increase
in the number of firms discussing the possibility of becoming
a bank with the regulators. However, we have yet to see an increase
in the number of new entrants. The regulators will report to Parliament
on progress in a year's time. (Paragraph 302)
Questions for future reviews
55. In
this report, we have set out a number of areas that future reviews
should examine further. In summary, the Financial Reporting Council's
investigation into the preparation, approval and audit of the
financial statements of Co-op Bank should consider:
a) How Co-op Bank's approach to recording impairments
differed to that of other banks up until the end of 2012;
b) Why KPMG apparently failed to uncover Co-op
Bank's particular approach to recording impairments;
c) Whether KPMG paid particular attention to
assets acquired in the Britannia merger in its annual audits from
2009 onwards, given the incomplete due diligence it performed
on them;
d) Whether the accounting treatment used to record
the costs for Co-op Bank's banking IT platform upgrade was appropriate,
given the delayed effect it had on Co-op Bank's regulatory capital.
The independent inquiry into events at Co-op Bank
and the circumstances surrounding them should consider:
e) Whether the FSA could or should have developed
superior stress-testing tools sooner than it did;
f) Whether superior stress-testing tools would
have led to Co-op Bank's loan impairments being discovered sooner;
g) Whether Co-op Bank's impairment profile—which
appeared to differ from that of other banks throughout the financial
crisis—should have led the regulator to inspect it more
closely prior to 2012;
h) Why the FSA's analysis on the Britannia merger
failed properly to account for the prudential risks attached to
the Britannia assets that have since been uncovered by the PRA;
i) Whether the work provided by KPMG and JPMC
on the Britannia merger met a reasonable standard, in substance
as well as form;
j) Whether the FSA was made aware of the change
made by Co-op Bank to the accounting treatment for its IT platform
replacement programme in 2010, and whether the FSA should have
foreseen and acted on its consequences—that is, delaying
the effect of the IT programme on the bank's regulatory capital;
k) Whether—given the conclusions of the
independent inquiry on the forgoing points and the FRC's investigation
on the late emergence of Co-op Bank's capital shortfall—Co-op
Bank's Verde bid could or should have been halted sooner;
l) What, if anything, further can be learnt from
the record of the Government's contacts with Co-op Bank and Group,
Lloyds Banking Group, the regulator, UKFI and NBNK during the
Verde bidding process. (Paragraph 303)
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