Why didn't FSA block Co-op's planned expansion?

Will the UK's financial regulators be cripplingly embarrassed by the Co-op's financial woes?

Perhaps not devastatingly humiliated, though perhaps mildly so - which means that there may be relatively more heat on the Treasury.

Here is why.

I am informed that the Financial Services Authority - which has now been broken up into the Prudential Regulation Authority and the Financial Conduct Authority - never approved the Co-op's abortive plan to acquire 631 Lloyds branches and thus treble in size.

Instead, a couple of years ago, it set the Co-op hurdles it had to get over to obtain that formal approval.

These hurdles were all officially, copiously and formally documented, and were about the amount of capital the enlarged bank had to have and operational capability, among other things.

I am reliably told that the Co-op Bank never surmounted these hurdles. One source said to me: "I never thought it would get over the hurdles; I never thought the deal would be done".

In the event, the Co-op pulled out of the planned takeover last month, before formally asking for the FSA's approval.

So, if the regulator always had its doubts that that deal with Lloyds would be consummated, why was it negotiated so expensively over all those many months.

And why did the Chancellor give it public support?

A source told me it was all about "MPs love of mutuals" and "the hope in the Treasury that an enlarged Co-op would be a decent competitor to the hated giant banks".

'Sense of complacency'

But if the FSA was never persuaded that the merger made sense, shouldn't it have vetoed it?

Well, I am told that the FSA did not feel it could block a deal that had so much support in Parliament.

All of which may be understandable.

But if the world in general was given the impression by the FSA's silence and the Chancellor's eloquence that the Co-op was fit enough to swallow all those Lloyds branches and assets, those right at the apex of the Co-op group in the biggest broadest sense - the Co-op that includes supermarkets, funeral homes, and so on - may have been lulled into a sense of complacency about the true state of affairs at the Co-op Bank.

The non-bankers on the Co-op's top board may not have asked tough enough questions about the true state of health at their bank. Which would go some way to explain why they learned only recently that property loans Co-op Bank acquired in 2009 with the takeover of Britannia are pretty stinky and loss generating.

And another thing. If the FSA was happy to stand back from giving a formal opinion on whether the Co-op was the right buyer of the Lloyds branches, will its successor body, the PRA, still hold its peace now that questions have arisen about whether the Co-op should stay in banking?

With all the uncertainties about how the Co-op will fill the hole in Co-op Bank's capital resources, it seems unlikely that the PRA will remain quite so arms length.