A nasty reminder from the financial meltdown in Britain overnight that the country’s banking industry remains a major threat to the stability and health of the economy. A new bank bailout could cost investors up to 300 million pounds ($A480 million) and affect more than 7000 retail investors, and it has already resulted in a shake-up at one of the country’s oldest business institutions.

The 169-year-old Co-operative Group has been bailed out to the tune of 1.5 billion pounds ($A2.4 billion). It gives us a flavour of how future bank bailouts would look in many countries, including Australia.

More than a month of talks with regulators, management changes at the bank and other discussions brought the statement overnight announcing the rescue. It’s the first of the so-called “bail-ins”, where creditors and shareholders wear much of the true cost of paying for losses and replacing lost capital before governments become involved in providing financial aid.

A bail-in rescue means some or all creditors play a part by copping a writedown on their investment in bonds or other securities sufficient to provide enough capital to cover any losses and provide the bank with adequate capital levels. It’s an attempt to end the idea that taxpayers (through the government or the central bank) are the first and last port of call for financial institutions needing to be rescued, as RBS and Lloyds were during the GFC.

Co-operative Group and Co-op Bank (of which Co-Operative Group is a majority shareholder) have been forced to compromise with the bank’s junior creditors by forcing losses on them and then forcing them to participate in the recapitalisation of the bank. Assets owned by the Co-operative Group are being sold to raise fresh capital to repair the bank’s weakened capital base. But this deal has a major difference to what was thought would be the structure of bail-in rescues.

So Co-operative Group escapes being wiped out and merely has to raise capital by selling off some assets. The junior bond holders are the ones that have been bailed in and had their existing securities wiped out and replaced with new ones and shares with an unknown value. This side of the deal has raised eyebrows in the UK, especially at the Financial Times, which is running a strong editorial against the move in its Tuesday edition.

It’s a black mark against the mutual system and shows that its supposed strengths of good management focused on customers, not fancy deals, can be undone by incompetence and poor oversight. Co-operative Bank has already been caught up in the 10 billion pound income insurance mis-selling scandal. Now the bank’s old management and that of the Co-operative Group have been exposed as being no better than the dud bosses at RBS, Lloyds or Barclays.

A worrying part of this debacle is that the Co-op Bank looked healthy until last three months ago, when a black hole suddenly appeared in the bank accounts as it tried to buy more than 600 branches from Lloyds bank (NAB also tried to buy these branches). It was found the bank had a capital shortfall of 1 billion pounds ($A1.59 billion) because of more bad commercial and home loans inherited in the takeover of Britannia Building Society in 2009. The problem hit the fan in April when bank called off the Lloyds deal and the bad debts and capital shortfall brought on the start of a crisis of confidence in the bank and its management (who were quickly replaced).

The sudden emergence of the financial problems resulted in Moody’s rating group slashing the bank’s rating six levels to junk status in May, which meant it was effectively priced out of credit markets for fresh capital or loans, unless it wanted to pay ultra-high rates of interest. The downgrade triggered the start of talks to recapitalise the bank — at a time when the outflow of deports increased as worried customers withdrew their money.

We don’t have anything like the Co-operative Group in Australia these days, only a few isolated mutually owned businesses in dairying and some building societies remain in existence. Local businesses modeled on the European idea of a bank, retailer or other business co-operatively owned by employees or members of a small comment or industry died out decades ago, unlike in Italy, Britain, France and Germany, where the idea flourishes to varying degrees of success.

Peter Fray

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Peter Fray
Editor-in-chief of Crikey