A devastating critique of failure at the Co-op Bank

The Co-op Bank is the subject of a scathing report by Sir Christopher Kelly. Photo: Rui Vieira/PA Wire/Press Association Images

Sir Christopher Kelly's review of what went wrong at the Co-operative Bank and the lessons that can be learned has taken eight months to complete.

He carried out 130 interviews (the only executive who refused to talk was Reverend Paul Flowers) and he sets out his findings with the care of an experienced civil servant. His conclusions are pretty devastating.

If you are in any way passionate about the Co-operative Group, and it has eight million members, you may want to find something to bite down on before you continue reading because what follows is painful.

The Co-operative Group lost control of Co-operative Bank last year when its financial position became unsustainable. The Kelly Report decides there were a number of factors that lead to the bank falling into the arms of its creditors: poor commercial lending, a colossal IT project that failed and the widespread mis-selling of Payment Protection Insurance (yes, in this sense the "ethical bank" behaved like any other).

The report author Sir Christopher Kelly. Credit: PA Wire

The consequences of these misadventures were terrible but were "magnified" by a weak governance structure which Kelly says made some sort of failure "almost inevitable".

The biggest single misjudgement, in Kelly's eyes, was the Co-op's decision to acquire the Britannia Building Society in 2009.

The Co-op was seeking the scale to take on the bigger banks, it wanted the Britannia's customers and its branches but it also inherited the Britannia's corporate loan book. In the years that followed £802 million of loans (mostly in commercial real estate) had to be written off. In the words of Kelly "due diligence...had been cursory," the assessment of potential losses "woefully inadequate". The Co-op had no idea what it was taking on.

Sir Christopher said buying the Britannia was the Co-op Bank's worst single misjudgment. Credit: John Stillwell/PA Archive/Press Association Images

The Britannia was cruising towards an iceberg. As Kelly points out: "In July 2011 the Regulator informed Co-op Bank that it believed Britannia would not have survived without the merger". Although Kelly also notes that, at the time, the Regulator did not block the deal.

It is Kelly's view that, following the merger, an awful situation was made worse when the chief executive of Britannia, Neville Richardson, became chief executive of the enlarged bank.

Kelly notes that although the Britannia was the UK's second largest building society, Richardson "had not worked at a bank before" and other members of his senior team "lacked appropriate experience". He suggests that "under alternative management a number of things might have turned out differently" although importantly he does not suggest that the bank could have been saved.

The report said Paul Flowers 'manifestly did not have the experience' to lead the bank. Credit: Lynne Cameron/PA Wire/Press Association Images

At the heart of banking lie two basic principles. The management of capital and the management of risk. Kelly argues that the Co-op Bank proved itself inadequate at both. His judgement is that executives should have realised that the bank was over-extending itself and should have ensured it was robust enough to absorb the losses when they came.

As it was things slowly began to unravel.

Neville Richardson told the Treasury Select Committee that when he stood down as chief executive in 2011 the bank was in a good position. Kelly decides there is "overwhelming" evidence it was not and that it was only on his departure that "past deficiencies" began to be addressed.

At the time Richardson left an IT project which went on to cost the Co-op £300 million was "foundering". The loan book was starting to turn and there was "little sign of a coherent strategy", according to Kelly, "other than to wait for things to get better".

Things didn't. Barry Tootle replaced Richardson as chief executive and "struggled". Then the PPI claims started coming, a legacy Kelly says "almost entirely related to the Co-operative Bank".

The bank's board seemed "oblivious" to what was happening and appeared "surprised" when, last spring, it was told it was under-capitalised to the tune of £1.5 billion. Kelly concludes the board must have paid little attention to a series of warnings "clearly and consistently identified by the Regulator over a long period of time".

Sir Christopher Kelly's review of what went wrong at the Co-operative Bank has taken eight months to complete. Credit: Press Association

Kelly says it was a "serious handicap" that successive Chairs at the bank (Bob Burlton and Paul Flowers) had no experience in banking. They missed what was happening but so too did the Group's board, lead by former chief executive, Peter Marks.

Kelly identifies "serious failings"in the way the board of the Co-op Group scrutinised the board of the Co-op Bank. It lacked a "clear strategy", appointed a Chair to the bank (Paul Flowers) who "manifestly did not have appropriate experience" and got "seduced" and ultimately "distracted" in 2011 by a futile attempt to buy 632 branches from Lloyds (the so-called Verde deal).

At the heart of the Co-op Bank's failure was a takeover that should never have happened but Kelly urges the Co-op Group to reassess the way its governed. Sir Christopher is clearly a great admirer of the Co-operative's core values but also makes clear that its democratic and complex structure ultimately delivered a management team that lacked the skills and experience the business needed to succeed.