LONDON (Reuters) - Britain's financial regulator warned the Co-operative Bank two years ago that it needed to raise capital and was not in a position to buy hundreds of branches from Lloyds Banking Group.
Andrew Bailey, the Bank of England's deputy governor for financial stability, told MPs the regulator had serious reservations about Co-op's ability to acquire 632 branches put up for sale by Lloyds as a condition of its 2008 state bailout.
Bailey said he had raised five issues of concern with the Co-op: capital, liquidity, risk management, integration, governance and management.
"It was a pretty full-set, roughly everything," he said.
Bailey said he believed Co-op had passed on the regulator's concerns to Lloyds.
"What I did do is say to the Co-op is it is your duty to inform Lloyds of this and they did, I believe they did. I've no reason to doubt that they did. I have evidence to suggest that they did," he told parliament's Treasury Select Committee.
Lloyds executives told the committee last month that they did not realise there was a problem with Co-op's capital strength until December 2012 when a revised plan for the integration of the two businesses was submitted.
"What we did immediately was to ask the Co-op about it, formally...they did not come formally to us and say, 'We have a problem'. They came to us and said 'This is the new combined plan'," Lloyds Chief Executive Antonio Horta-Osorio said.
Peter Levene, who fronted a rival bid from banking venture, NBNK, last month presented a document to the committee that he says he gave Lloyds chairman Win Bischoff in January 2012, raising questions over why Lloyds was not aware of the issues earlier.
The document said there was a "high risk" that the Co-op's purchase of the branches would fall through, citing its stretched capital position and execution risk.
Despite those concerns, talks between Lloyds and the Co-op continued until April this year, when Co-op was found to have a capital shortfall, which the regulator has since identified to be 1.5 billion pounds.
The decision by Lloyds to sell the branches to Co-op prompted allegations that politicians - keen to back customer-owned financial services businesses, such as Co-op, as an alternative to mainstream banks - had encouraged the choice.
Lloyds said it was not subject to political pressure and made the decision to back Co-op's bid for commercial reasons.
Co-op on Tuesday declined to comment on details of the Verde talks with Lloyds but pointed out that it had since brought in a new management team led by chief executive Euan Sutherland. The bank had previously said it would review what went wrong when its restructuring is completed.
Co-op is forcing bondholders to help plug its capital shortfall shortfall, using a 'bail-in' rescue model which will see them swap their debt for new bonds and equity in the bank, losing 500 million pounds in the process.
(Editing by Louise Ireland)