This time last year, the bank was riding high. Its commercial competitors were being pilloried for their involvement in the manipulation of Libor, the mis-selling of payment protection insurance and for nearly bankrupting the country.
There was widespread talk about the desire for real alternatives to commercial high street banks and the Co-op Bank was seen as one of the leading lights. Here was a bank that had members, not customers. It avoided the kind of high-risk trading activities which so many other high street banks had been seduced by. It had ethical values baked into its very soul.
The lender had been given a shot of energy by all this public celebration. It had already absorbed the Britannia Building Society and had announced growth plans to take over many of the branches of Lloyds. Such a move, it was thought, would make it large enough to compete with the other big high street banks.
At this point everything began to unravel. First, the acquisition of the Lloyds branches fell apart. Then came a Bank of England report which revealed a £1.5bn hole on the bank’s balance sheet. This triggered the third act of the tragedy, during which the bank was ‘bailed in’. The result was that bondholders in the bank became shareholders. For many small bond investors, it meant they were no longer guaranteed relatively high and steady returns. For the bank, it meant that it was no longer owned by the co-operative movement. The majority shareholders were now US hedge funds.
In ownership terms, this meant the Co-op Bank was effectively like any other commercial bank with shareholders looking for a return on their investment. Senior management was insistent the bank would maintain the co-operative values that made it special. But this looked like little more than a bit of ethical window-dressing designed to make the newly commercial bank look cuddlier. Members of the Co-op Bank are not fools. They realised that what was happening was a commercial takeover of their cherished institution, which led many to look for alternatives.
Late last year this tragic story turned into a farce. The Mail on Sunday published a story alleging that Paul Flowers, the chairman of the bank, procured illegal drugs. He was a Methodist minister who chaired an ‘ethical’ financial institution. The behaviour of Reverend Flowers might seem disgraceful, but many commentators realised the real scandal was the fact that an individual with little experience in banking could come to chair one of the largest banks in the country. Mr Flowers was by no means an outlier. The board of the Co-op Bank was full of people with little formal knowledge or experience of banking.
The problems in governance, revealed by the Reverend Flowers affair, led many to ask if the Co-operative Bank had a seriously flawed system of governance. Were the mechanisms of governance in place fit for purpose or had they actually caused the decline of this great institution?
To answer these tough questions, a number of reports were commissioned. In the past weeks, we have seen the release of two reports exploring governance failures at the mutual. The first was by Sir Christopher Kelly on the events leading up to the ‘bail in’ of the Co-op Bank, and was quickly followed by the release of the Lord Myners review of the governance of the wider Co-operative Group.
Both the Kelly and Myners’ reports made for fascinating reading. They were kind of corporate who-done-its. Sir Christopher was characteristically careful and relied on the formal assessments of a bureaucrat, while the Myners report was different. He cut through the carefully worded corporate balderdash that is all too often a feature of such reports. You got a sense of a man talking about an organisation he is passionate about – his frustration oozed throughout the report. Thankfully, his straight-talking approach got through to Co-op members and it is a pity more reports on governance failure are not so clear, direct and personal.
The Kelly review painted a picture of a bank gripped by stupidity. The bank avoided appointing experienced people who were willing to ask uncomfortable questions. This meant senior managers were free to pursue grand plans that were not properly thought through. This appeared to work for some time as the bank expanded following the financial crisis, but the results of institutionalised stupidity came home to roost with the failed integration of Britannia Building Society, the disastrous plan to acquire Lloyds branches and lack of foresight about the bank’s capital position.
The bank’s culture was a text-book case of functional stupidity. It appointed inexperienced people, avoided criticism and challenge, focused on good news, indulged in unwarranted optimism, let itself be carried along by events, sealed itself off from outsiders and kicked problems down the road. This created an illusion that the bank was growing into a major player. But this distracted the bank from real problems, such as integrating Britannia, managing the bank’s capital position and dealing with the IT platform.
Sir Christopher also pointed out that the bank had made some rookie mistakes in governance. The executive had too much freedom, they were not challenged by independent directors and internal critics seemed largely absent. The inevitable result was chief executive hubris, corporate over-reach and an unwillingness to candidly question decisions.
Due to the lack of oversight, the bank pursued the corporate actions which routinely fail – mergers and acquisitions and large scale IT projects. Often when there is trouble with an organisation’s core business, chief executives welcome the distraction of a large M&A. It might make the organisation feel like it is growing, but M&As rarely produce real long-term value. They are more likely to create long-term headaches.
The Myners review focused on the Co-op Group as a whole, rather than just the bank, and there were remarkable similarities with the Kelly report. The Myners review called for a board that is smarter, simpler and selfless with more say for members. Smarter because it required directors to have significant board experience, simpler because it got rid of the complex regional board structures, selfless because it encouraged board members to act in the interests of the Co-op (and not their own self-interest), and more say because it proposed a one member, one vote structure. The recommendations reflected standards of good governance not just in the corporate sector, but in other sectors as well.
The impact of the Kelly and Myners reviews is far from certain. It seems the Co-op Bank is continuing its journey to become more like a mainstream bank, governed by seasoned investors. Recent reports have suggested the Co-op Group’s holding of the bank could further dwindle from 30 per cent to 20 per cent. This will probably mean governance is more professional, skilled and efficient, but is likely to remove many of the qualities which had made the Co-operative Bank special, such as including the democratic voice of members.
This is a pity not just for the co-operative movement, but the wider banking system because co-operatives tend to be more efficient than their commercial competitors. In addition, the presence of alternative business models – like the Co-op – tends to force commercial competitors to be more efficient as well.
Reforming governance in the wider co-operative movement is going to be tough. The main barrier is a tendency to kick the can down the road rather than deal with the problem. The problems are urgent and need to be resolved, as the industries the Co-op operates in are undergoing massive change. Some might ask if corporate giants like Tesco and Barclays are struggling, what chance does the Co-op Group have?
Andre Spicer is professor of organisational behaviour at Cass Business School
