1. The Co-operative Bank – Financial Competence – The Struggle to get back to Solvency

a. The original gap in the bank’s finances was mainly due to a 2009 merger with the Britannia Building Society. As part of that deal it absorbed some big commercial property loans, which returned significant losses leaving the bank exposed. Under banking rules, banks need a certain amount of capital in place to be considered stable, and the Co-op had to act to make sure it had enough.

b. A “bail-in” plan was approved by the BOE. This excused the public from any financial outlay since the bank turned to it’s bond/shareholders to raise the required funds.

c. The first £1bn was generated through an exchange deal with investors holding “subordinated capital securities” or bonds – In effect they loaned the bank money in return for a regular interest payment. But instead of the interest payment and their existing stake in the bank, they were offered a choice: they could either take shares in the bank, to be listed on the stock market; or accept a new investment offering a fixed interest rate.

d. Some investors were holders of permanent interest bearing shares (Pibs), offering high fixed interest rates – in the Co-op’s case, investors had been receiving annual returns of between 5.5% and 13%. Instead of getting cash as expected, and being able to cash in their Pibs at some point in the future for their face value, they were also required to take part in the exchange, together with large, institutional investors. The move also impacted on around 7,000 individual investors who made up about 5% of the bank’s bondholders. The initial value of the new holdings was markedly reduced by (20-30%). An additional £500m was raised from the sale of the bank’s insurance arm and some other assets, and from other cost-saving measures.

e. Customers with current accounts and savings accounts did not lose any cash deposits and The Co-op Group stressed it was still the majority owner of the bank, and that it intended to remain a mutual. However, the stock market listing for part of it meant a significant change of direction should shareholders require the bank to maximise profits.

f. Andre Spicer, professor of organisational behaviour at Cass Business School, said the change in the bank’s business model going forward “was likely to clash with the co-operative ethos of the bank and, in the longer term, this might undermine what had made the Co-op attractive to its staff and customers.” http://www.theguardian.com/money/2013/jun/17/co-op-bank-bailout-what-means-customers

2. UK Bank of England – Stress Test Regime – Frances Coppola, Expert Comment, (paraphrased):

a. It is certainly possible that the UK might experience deflation as the Eurozone, with which the UK is entangled through a complex web of trade and financial ties, sinks deeper into its self-imposed depression.

b. Since the UK is one of the most highly-indebted economies in the world, a deflationary crisis would be every bit as bad for the UK as an inflationary one. Yet the Bank of England chooses to ignore this and focus on last century’s war. This is not to say that an inflation-induced economic crisis should not be tested: but a deflationary one should also be tested. The Bank of England is making the same mistake as the EBA. Simply making a test more severe does not make it any more valid.

c. Rising inflation is not a greater risk than falling inflation: indeed, for a highly-indebted economy such as the UK’s, falling inflation is arguably the greater risk. The Bank of England’s stress tests are every bit as flawed as the EU’s.

3. UK Bank of England Stress Testing – (annual from 2014) – Doomsday Scenario.

a. The Bank of England has made it clear that the doomsday scenario is not something that it thinks is likely to happen at the present time. It is an attempt however to replicate bad news piled upon bad news such as occurred in 2008. But given that the present risks in the economy include a collapse in the oil price and possible deflation in the eurozone, indeed some argue that the Bank is testing the wrong thing. However eight UK banks were subject to stress testing in December 2014. The scenario;

i. Sterling falls by about 30%

ii. House prices fall by 35%

iii. Bank rate rises to 4.2%

iv. CPI inflation peaks at 6.6%

v. Unemployment rises to nearly 12%

vi. GDP falls by 3.5%

vii. Share prices fall by 30%

4. Stress Testing Outcomes

a. The Co-operative Bank, which had to be rescued last year after a £1.5bn black hole was found in its balance sheet, was the only bank deemed to require a “revised capital plan”. Whilst the Bank had divested itself of a number of risky assets much work needed to be done to “significantly reduce other risk-weighted assets”. Officials were quick to point out that customers need not worry about their deposits, as The Financial Services Compensation Scheme protects the first £85,000 of savings per person, per institution. But given that the present risks in the economy include a collapse in the oil price and possible deflation in the eurozone, some argue that the Bank is testing the wrong thing.

December 2014; http://www.bankofengland.co.uk/financialstability/Pages/fpc/stresstest.aspx December 2014; http://www.bankofengland.co.uk/publications/Pages/news/2014/169.aspx

December 2014; http://www.bbc.co.uk/news/business-30491161 December 2014; http://www.telegraph.co.uk/finance/newsbysector/epic/rbs/11297460/RBS-raises-2bn-to-pass-Bank-of-England-stress-test.html

5. December 16 2014; Remedial Measures – Co-operative Bank – Bank to Sell-Off Further Assets After Failing Stress Test

a. The Co-op Bank plans to sell £5.5bn of mortgage assets by 2018 after failing the Bank of England’s “stress test” of its ability to withstand another financial crisis. The bank’s chief executive had already conceded that it would probably not pass the test, having insufficient capital to cope with the most severe economic shock. To improve its balance sheet position the Co-op Bank has drawn up a new list of assets for disposal increasing capital funds. http://www.thebusinessdesk.com/northwest/news/706374-co-op-bank-plans-sell-off-after-failing-stress-test.html

6. European Banking Authority (EBA) – Stress test Regime – Expert Comments:

a. Raoul Ruparel: Head of Economic Research at independent think-tank Open Europe: Overall, the tests are a bit of a mixed bag. There is provided a great amount of data and some useful insights and standardization for the European banking sector. The stress test, as with its predecessors, continues to be plagued by simplistic and optimistic scenarios for the Eurozone as a whole, meaning specific pockets of risk are not properly tested. In any case, these tests alone were unlikely to ever mark a huge turning point for the Eurozone given the wider problems. Attention will once again switch back to the reform process and the role of the ECB in supporting demand.

b. Frances Coppola: Designer of risk management systems: My conclusion is that this exercise is, like the proverbial curate’s egg, good in parts. It has undoubtedly improved transparency and prudent asset valuation. But it has not proved that the banking system is resilient to even the current downturn, let alone a future one. http://www.pieria.co.uk/articles/european_stress_tests_not_stressful_enough

7. What Next for the Co-operative

a. It is entirely possible that the weakest of the UK banks could fail. The City might not be keen on taking on the losses of a mutual company. This would place the UK government in a difficult place since a taxpayer bail-out would in effect be a Nationalisation. But there is no precedence for government to act upon. The Co-op finance at least 180 MP’s and many 1000’s of Councillors and provide significant financial preferential loans to the Labour Party. Such a bail-out would be challenged through the courts since a political Party would then be financed by the state. It might be the Co-op would be persuaded to give up it’s share of the Bank to the City but the effect would be catastrophic for the MP’s, Councillors, and the Labour Party. The City takes no prisoners and might call in the loans. An interesting scenario.