It is understood the Prudential Regulation Authority (PRA) has begun drawing up contingency plans for the troubled bank, which put itself up for sale last month amid mounting concerns about its capital position.
If Co-op Bank is not bought, it will be forced to attempt a costly restructuring that would result in bondholders owning the lender in return for its debts being wiped out reports The Telegraph . If a rescue is not forthcoming, the PRA would step in and force the bank into resolution, which would result in it being wound up.
It is understood that the PRA has been working with external advisers to help map out a rescue plan.
Intervention by the PRA would mark the first time the Bank of England has rescued a financial institution since the failure of Dunfermline Building Society in 2009.
Co-op Bank’s woes are the legacy of its disastrous takeover of the building society Britannia eight years ago, which saddled its balance sheet with bad loans. Last month, Co-op Bank revealed it was looking for a buyer for its entire business to bolster its finances. However, rivals believe that while there may be bidders for parts of its business, it will struggle to find a suitor willing to buy the entire bank.
If the sale process fails, the lender has said it will try to raise £750m from its existing investors through a debt-for-equity swap and £300m of fresh equity.
However, some of its hedge fund owners are understood to be sceptical about putting new money into the struggling business. The funds might push for new management at the bank as a condition of taking part in an emergency fundraising.
In 2013, Co-op Bank discovered a £1.5bn hole in its finances, forcing a group of US hedge funds to rescue the lender. In the same year, its former chairman Paul Flowers became embroiled in a drugs-and-sex scandal.
Co-op Group now holds just 20pc of the lender, with the balance held by hedge funds including Silver Point Capital. The bank’s chief executive, Liam Coleman, and his team have been trying to turn it around since 2013, but have been hampered by rock-bottom interest rates. Co-op Bank posted a loss of £477m for 2016, its fifth consecutive year in the red.
The losses have eroded the lender’s capital buffer and in January it warned that it was “unlikely” to meet its so-called individual capital guidance –which is set by the PRA – between now and 2020, sparking fears for its future.
The Bank of England and Co-op Bank declined to comment.