Bad management, naive governance and sloppy regulation are again to blame, says Philip Augar

“How did things ever get so far? I don’t know. It was so unfortunate, so unnecessary.” The question Don Corleone asked the heads of the five families in The Godfather might be asked by the board, management and regulators of the Co-operative Bank, currently enduring humiliation, disgrace and embarrassment. And while the Treasury and its not-quite-at-arm’s-length friends at UK Financial Investments might count their lucky stars they were not directly involved in bailing out the failed bank, they might like to reflect on whether they should have been as the Co-op’s demise further diminished banking diversity on the high street.

The Co-op’s bewildered members and customers, not to mention the creditors forced to accept a haircut in the hedge fund-led rescue of the bank, must be wondering what on earth was going on.

The merger with Britannia in 2009 was typical of many deals in the immediate aftermath of the credit crunch. Bargain-hunting was what banks did then to please shareholders. But the Co-op did not have shareholders to please, because it was a mutual society. Its management thought it could produce bigger dividends for members and offer better service to customers if it had “scale”, the siren that lured many other financial services businesses on to the rocks. In reality it bought a loan book stuffed with debts about to go bad and an IT project that was about to go south.

Such mistakes were typical in the overextended, over-optimistic days of the financial services bull market. But the point is that unlike their shareholder-driven rivals, the Co-op had no need to be playing such an ambitious high-risk game. It was batting out of its league and there was simply no need for it to do so.

Bad judgment in 2009 was compounded in 2010 with the appointment of Paul Flowers to chair the bank. By this stage, events in the sector, where banks were falling like skittles, should have made it clear that chairing a bank required banking experience; Mr Flowers had next to none. Furthermore, insiders who had followed his career questioned his judgment and suitability for a specialist role of this seniority. The Co-op board and the regulators appeared not to worry and waved the appointment through.

By 2013 the personnel had changed but the lack of grip had not. Despite mounting problems with the loan book culminating in a £1.5bn hole in the balance sheet, the Co-op persisted with a mooted purchase of 631 bank branches from Lloyds before suddenly pulling out in April. By taking another transformational deal so close to the wire at a time when its balance sheet was falling apart, management appeared out of touch with the reality of its business.

The Financial Services Authority, the bank’s regulator at the time that the key mistakes were made, missed many opportunities to intervene. It was the prudential regulator responsible for banking stability and it screened senior management appointments. The FSA is history now; so are its mistakes – but the consequences linger.

One is that the Co-op Bank’s collapse reduces diversity among high-street lenders. Diversity matters not because mutuals are necessarily better managed than listed corporations but because they are different. They have a different set of objectives, can operate off a different timeframe, have different values and appeal to a different set of customers. They can take a regional approach and view their customers as partners, not counterparties. The principle of individual co-ownership is thus an important alternative to remote, institutional control. The Co-op Bank’s new shareholders, led by the hedge funds Silver Point and Aurelius, have pledged to adhere to its traditional values. We shall see.

Just as the Co-op Bank was revealing its latest embarrassment, another British mutual bank – Nationwide – produced results that show the model to be perfectly viable. It was a timely reminder that the Co-op’s failure was not a reflection on the mutual movement as a whole but was down to the usual culprits in banking; bad management, naive governance and sloppy regulation. It was all so unfortunate, so unnecessary.