The Co-op Bank: M101 Banking

by George Hatjoullis

The press coverage and comments around the Co-op rescue have been both surprising and annoying. The blog has started to look like M101 Banking so I may as well continue.

The Co-op capital shortage has been resolved. The press and their readers seem surprised it has been resolved without recourse to taxpayer money. No surprise at all. Taxpayer funds should only ever be involved in bank rescues if, and only if, there is systemic risk. This means if the bank failure in question could infect the system and trigger other banks to fail, causing a catastrophic cascade. This was never the case with the Co-op. It was the case with Lloyds Bank and RBS. In such cases taxpayers should welcome the intervention even if they have nothing in the bank. The reason is that, if the cascade is triggered, the consequences would most likely be a 1930s type depression and every taxpayer would suffer. The action of the UK government did not bail out bankers or their bonuses. The action bailed out the economy. The economy has suffered but not as much as it might have done.

Consider what would have happened if the banks had not been bailed out. RBS, Lloyds and various smaller banks would have ceased trading. The linkages would have meant that at least one other large bank (e.g. Barclays) would have also been brought to the brink of failure and may well have failed. The failures would have wiped out the shareholders, preference shareholders and junior bond holders ( e.g the Permanent Interest Bearing Shares and Perpetual Subordinated Bond holders).  However, it would not have stopped there. It would have damaged the senior bond holders and uninsured depositors, much like the haircuts experienced in Cyprus. Recall  that when the crisis started deposits were only insured below £50k. Finally, in 2008 the crisis was so severe that even the insured deposits were at risk and there is no way the FSCS, which is funded by a levy on banks, could have covered all insured bank deposits. The government would ultimately have picked up this bill in any event. Taxpayers and bank depositors alike should thank the government for its action. They should also look at the proposed banking union for the EU/eurozone and recognise that using taxpayer funds in this way may not be possible in the event of a systemic crisis. One should ask how the proposed banking union will deal with systemic crises. They do happen.

Returning to the Co-op, the resolution involves some capital contribution from the parent group and a bail in of the PSB holders. This is as expected and was discussed in my first blog ( ) on the subject of the Co-op. The PSB holders are complaining. Why? PSBs are junior debt and constitute part of the capital base of the mutual society. They are designed to facilitate liability management exercises such as this. Neither the capital nor the coupon on these instruments is guaranteed, the coupon is paid at the discretion of the mutual and, unless otherwise stated, is not cumulative. The instruments offer a better yield at issue because they are riskier than other instruments. The clue is in the higher than average yield at issue!

The real issues here were raised in the previous blog. Why was the Co-op pursuing expansion without adequate capital? Why was the government encouraging it to do so? Why did it take several months before the lack of capital, which became public information in February, was properly reflected in the price of PSBs? Why did it take a discontinous rating change to wake everyone up? This is what the press should be looking into. I should like to add why were PSBs held by any people who did not grasp the risk inherent in these instruments? Who advised them to do so? The clue is in the name; Perpetual Subordinated Bond. The degree of financial illiteracy in the population is staggering.