Smile: It's a Co-operative Bank

It's been a challenging few weeks for those of us who hold an ideology to the left of the political spectrum. I don't know whether I was more astonished to discover that the road to serfdom goes via the Brixton Maoist Centre or that my apparently ethical bank was actually being run by the 'crystal methodist'. I'm only waiting to discover that Shelley was an incestuous just peadophile for my despair to be complete.

I would hazard a guess that you shared my frustration after the financial crisis to hear from many economists and their media supporters that the answer to the disaster was not fewer markets but more markets. So I hope you will forgive me if I will paraphrase this response and argue that the answer to the crisis in the co-operative sector is more mutualism not less.

Ed Mayo, Director of Cooperatives-UK has been quoting the Financial Times's comment that the problem with the Co-operative Bank was not that it was a co-operative but that it was a bank. I would take issue with this comment on the basis that the Co-operative Bank a co-operative in the sense in which I understand that term. It was the bank of the Cooperative Group but it was never a membership organisation and I could never influence it policy although I have had my account there for years.

As an earlier guest post on this blog demonstrates the bank was following its market competitors by engaging in a whole range of activities that I feel its customers and members would never have sanctions have they been offered a choice. The contrast between the activity of the Co-operative Bank and the Nationwide Building Society, a large but none the less mutual organisation, is instructive. The Nationwide, a genuine mutual which has more than doubled its 'profits' this year, is anxious that it is not tarnished by the problems at the non-co-op Co-operative Bank.

For me the principles of co-operation are not challenged by the antics of Mr Flowers. Businesses run by the members for the benefit of the members and that do not deliver services to external shareholders are still the ideal form of economic organisation in my book. I have an account with the Co-operative Bank because it was part of the movement that subscribes to these values; I was always disappointed that it was not a genuine cooperative.

The problems for the co-operative movement is that it appears to have lost it sense of purpose and its ethical stance is now under challenge. To save its reputation it needs to divorce itself from those who would influence it, whether market players or Labour Party insiders. We need the cooperative to become truly ours. It is our job to wrest control back from those who would use it in their sectional interest and to make it the truly mutual business sector it has always promised to be.
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One Rule for the Rich?

My suspicions were aroused when the credit-rating agencies started criticising the capital holdings of the Co-operative Bank. After all, any bank is effectively bankrupt at all times, so pointing the finger of accusation just becomes a self-fulfilling prophecy. I put my suspicions down to paranoia, but now that the BBC's Robert Peston is starting to make similar noises about the Nationwide I am beginning to wonder whether I wasn't suspicious enough.

As Peston notes, the response by many to the disasters and calumnies of the banking corporates has been to look in the direction of mutual ownership. I have called for the Royal Bank of Scotland, rather than being sold back to shareholders, to be broken up into a system of local community banks, owned by those in the local economy who would uses their services, and with boards made up of local businesspeople, councillors, and citizens. Green MP Caroline Lucas made a similar point during her intervention in the banking debate earlier this week.

The logic is clear: if we, the public, provide the guarantee that allows the banking system to have credibility while operating in a state of permanent insolvency then we should have control over how it directs credit and should also see the profits from banking invested for public benefit not private gain. The redistributive effects of such a shift would be massive, which may be why the commentators are now portraying mutual financial institutions as unreliable.

Yesterday's suggestion from credit-rating agency Moody's that the situation is improving for the commercial banks is the final piece in the puzzle. Since the problem for both the Co-operative Bank and the high street banks is that they are holding commercial property assets that have massively lost value since the crisis, it simply cannot be right to say that their credit ratings are moving in opposite directions, at least not if you take this as an independent indication of financial health, rather than a piece of political propaganda. The rules set by the Basel Committee as to what counts as a reliable form of capital are similarly prejudicial to the interests of building societies, whose assets really are safe as houses and far less subject to risk than the complex financial instruments counted as assets by the banks. Nationwide boss Graham Beale made a similar point in an interview with the FT recently.

The inconsistency with which mutual and shareholder-owned financial institutions are being treated by financial commentators leads to an unsavoury conclusion. Could it be that, having used austeria to attack public services and the working conditions of those employed throughout the economy, the defenders of capital are now using it to destroy the vestiges of the co-operative and mutual economy?
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When is a Co-operative Not a Co-operative?

I was glad to be able to host Peter Pannier's well-informed explanation of the travails of the Co-operative Bank. Since I have spent years recommending on this blog and in public talks that people shift their bank accounts to 'the co-op' I feel a responsibility for its failure. For me, criticising any part of the co-operative movement feels like attacking a member of my own family and I am well aware of the glee with which capitalist apologists are greeting the bank's problems. But if the advantage of mutual economic is our genuine ownership the along with this comes a responsibility to be questioning and critical.

My reluctance to comment is also because I have long known that the answer to the question is 'when it is the co-operative bank' but I have never been sure of the exact ownership structure of the bank. The organisational chart shows that the bank is owned by the Co-operative Group. It is the co-operative bank because it is the banker to the co-operative movement, not because you own and control it if you have an account. We know that anyway because we have never elected the directors and did not get to vote on the decision to buy up the Britannia.

Which brings us to the nub of the problem. Peter Pannier's data demonstrate to my satisfaction that bad decisions were taken by Britannia executives which led to the crisis of solvency. It was exacerbated by the financial crisis but was vulnerable before. Like the managers of other mutuals, at Britannia the directors seem not to have understood the market they were involved in.

I am still left questioning why the credit-rating agencies condemned the Co-operative Bank because of the weakness of its lending against commercial property when they have not done this to the other banks who are holding loans to businesses that are effectively bust and whose collateral has lost so much value since the beginning of the recession that the loans are bound to be bad.

A second question: if the control of the Co-operative Bank now passes to shareholders, as the result of a grand-scale debt-for-equity swap, is it worth continuing to hold an account? We are promised that ethical standards will continue but if your motivation is to avoid the extraction of value by the holders of capital you are left with a difficult decision.

In trying to see the bright side to this gloomy news I am left asking whether it offers evidence of solidarity that you would hope to find in the mutual sector. Just as with the collapse of some of the building societies, which were absorbed by others, the decision to buy the Britannia was argued at the time to be about gaining access to the High Street, but was it really about supporting a mutual in trouble? If not, one is left with serious questions about the quality of the due diligence that was undertaken.

You might also argue, a a pinch, that the solution announced earlier this week is based on self-help. The movement has come up with a plan that avoids government involvement, although it reduces the proportion of the bank that can still be considered 'co-operative'. Many of the bad decisions made by co-operatives and mutuals, especially their excessive borrowing from financial markets, resulted from an attempt to compete in a capitalist market, which is always a weakness of the idea of co-operation within capitalism.

But even these reasons to be cheerful cannot conceal that we are losing a bank that has been part of the co-operative movement for 150 years. As capitalism's crisis slouches on, this seems to be yet another example of how it is sheltering its own while the interests and institutions of working people are being sacrificed.

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What is Going on at the Co-operative Bank?

A longer-than-usual guest blog by Peter Pannier and begins a process of analysis of the troubles at the Co-operative Bank and their implications for UK mutual and/or financial institutions (questions and comments welcome via @peterpannier on twitter)

The idea that the Co-operative Bank and the 47 remaining building societies represent a positive alternative to mainstream banking been most enthusiastically pushed recently by the Move Your Money organisation as well as by anti-capitalist activists, Greens and supporters of the alternative economy. So where are we following the furore surrounding the Bank's 'rescue plan'?

Yesterday (17 June 2013), the Co-operative bank announced its plans to meet the capital requirements of £1.5bn (non-specialists might prefer the Guardian summary). This follows a decision earlier in the year to abandon a bid to take over 631 branches from Lloyds Banking Group, dramatic downgrades by Fitch, S&P and Moodys, and a changing of the guard at the boards of both the Bank and the wider Co-operative Group.

Some people have started asking some pretty good questions about what went wrong at the Co-op: Ruth Sutherland comes up with a dozen and more recently Patrick Collinson put forward another eight.

The problems can be traced back to the takeover (announced in October 2008 and completed in August) of the Britannia Building Society, where the issues were:

• A high volume of (mispriced) commercial property loans, made at the top of the market. With empty shops and low consumer demand, this portfolio seems unlikely to regain any value in the near future.

• A high volume of (mispriced) risky mortgage lending, also made at the top of the market. Again, arrears and repossessions are rising, real wages are falling (meaning making mortgage payments is getting harder), while we still have record low interest rates.

• The need to raise capital ratios because of higher capital requirements instituted since the financial crisis, and the difficulty of doing this through retained profits.

• An inability to raise capital by issuing shares. Many people have suggested this is because of the banks mutual status, but this is wrong. The Co-operative Bank is a plc, hence its ability to convert bonds into listed shares (see this diagram of the ownership structure). The reason the Co-operative Group could/cannot raise capital through issuing equity is two-fold. First, despite the fact that its ownership model does not prohibit it, it has been trading on the idea of being a ‘mutual’ ‘alternative’, and shareholder equity doesn’t fit with this PR image. Secondly, if it tried to issue equity while in crisis it would likely experience the same problem as RBS – no-one wants to buy shares in your bank when it looks like they are going to be throwing their money away. Hence why it has converted bonds (which don’t count toward capital) into shares (which do) instead.

Before the merger with the Co-operative Bank, Britannia was the second largest Building Society in the country. Contrary to perceptions of building societies being safe, traditional, and guided by ethics and principles rather than profits and growth for their own sake, Britannia was following a business model not dissimilar to those of HBOS and Northern Rock: borrowing from the wholesale markets to fund asset growth, frequently via mispriced risky lending, with an increasing interest in (large) commercial property loans.

Perhaps the aspect of the Britannia’s business model that made it most vulnerable in the crisis was its high reliance on wholesale funding. In the UK, building societies face a regulation that means they must raise 50 per cent of their funding from individual retail depositors. Everything else (wholesale borrowing from the short-term money markets and longer-term capital/bond markets , combined with non-retail deposits from other organisations such as local authorities) counts towards the ‘Funding Limit’. Britannia had the highest funding limit ratio of any building society at year-end 2008, and in all but one of the previous five years (it was still the fifth highest in 2005).

Just as they face regulation on liabilities side of the balance sheet, building societies are also limited in the kinds of assets they can hold: they must hold 75 per cent of commercial assets (liquid assets are excluded from this calculation) in the form of residential mortgages. Here too, Britannia was pushing the limit.

In 2008, the lending limit ratio was the highest for a UK building society. Though this was not true in previous years, the trend line is worrying: the Britannia was rapidly increasing the proportion of its lending not in the form of residential mortgages. A particular focus was commercial property, and rather than building up a portfolio of small, relatively safe loans to B&Bs and flats above shops, £900m of the £1.7 bn of ‘impaired’ loans is from just 12 big loans (Collinson, 2013: url, paragraph 1).

This is not to say Britannia were not also making lots of mortgage loans: in terms of mortgage lending as a percentage of prior year loans, Britannia were the 7th fastest growing building society 2007-2008. It appears that the decisions about who to lend to were not well made: 'Impared loans on a book of former Britannia mortgages known as 'Optimum' are running at 17 per cent--way above the industry average--with £1.2bn. of home loans at risk of going bad . . . Across the Co-op Bank’s whole mortgage book, 6 per cent of lending is classed as impaired. A further £1.1billion of loans are in ‘forbearance’, meaning borrowers in supposedly temporary straits have agreed a deal such as a payment holiday.'

In hindsight, these graphs and statistics show that Britannia went into the crisis with pretty much the worst business model possible. It would perhaps be OK if there had been profit in this model, and it was all being put into capital in case of the eventuality that things didn’t turn out well. Unfortunately, as the next graph shows, even as it continued to lend more and more, and in areas theoretically more risky for a building society, Britannia was making less profit per pound of lending (in other words, mispricing risk on a grand scale). I cannot believe that these graphs were not considered as part of a due diligence process (but, if you read the PR from the time you might conclude otherwise).

According to my analysis there are three broad reasons why the merger took place:

• The Co-operative Group had long wanted to take on / offer an ‘ethical’ ‘alternative’ to the larger retail banks in the UK. It had identified various large building societies as routes to this objective, lobbied for the Butterfill Act and took the opportunity when it came, paying little or no heed to the realities of Britannia’s past or the unfolding financial and economic crises. This might also explain the wholly misguided project of taking on the Lloyds branches.

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• The Co-operative Group was interested in growing its banking operation (consistent with above). The senior management at the Co-operative Bank did the due diligence on Britannia, and decided that the risk was worth taking on. Such a conclusion would rely on an expectation that the UK economy would recover strongly and quickly, and that the turmoil in financial markets would end soon.

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• The Co-operative Group did the due diligence on Britannia and, given this and the deteriorating economic environment and continuing turmoil in financial markets, decided it would rather not take it on, but gave in to pressure from the FSA and government to persuade it to do so.

As far as I’m concerned Option 1 amounts to hubristic foolishness, Option 2 amounts to naive optimism and Option 3 amounts to dangerously craven weakness. The Co-operative Bank was facing a capital shortfall of £1.5bn. I personally cannot see how selling off great chunks of your business (life and general insurance arms), ceasing lending to new business customers, and undermining your brand by introducing external shareholders to what had been considered a ‘mutual alternative’ are going to combine to create a business model that can ride out the problems that remain.

Just about the only shining light for the Co-operative Bank is that, thanks to a reputation for customer service and an ethical stance, it has in the words of Frances Coppola 'an amazing customer base which has been astonishingly loyal'. Some of the Co-operative Bank’s customer base will remain loyal. However, for new customers (of whom there were apparently as many as 100,000 last year) this loyalty will be very shallow. Anecdotally, such customers feel betrayed and are already leaving. Even old and traditionally loyal customers may reconsider their relationship with the Bank following the introduction of shareholders and the associated incentives to maximise short-term profits, not to mention the revelations of previous bad management. If I were a retail customer, I’d certainly be thinking twice. Perhaps more to the point, I’d wager that larger borrowers and investors aren’t feeling too positive about the Co-operative Bank at the moment, and that won’t help them one bit.

But this isn’t the bad news. The bad news is that the UK financial crisis of 2007-8 was not solved, but merely deferred (much like the crisis of the 1970s that lies at the root of our current problems). The problems at the Co-operative Bank are just the beginning. Your money is probably safe (assuming you haven’t got very much), but our financial and economic systems still very much are not. The storm that is coming is as likely to selectively avoid particular ownership models in finance as nature’s storms are to avoid houses on the basis of whether they are owned by the occupier, a landlord or the local authority.
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