Co-op capital hole threatens Lloyds deal The Co-operative Bank is facing a capital hole of up to £1bn, equivalent to half its capital, which is further undermining the lender's planned acquisition of more than 600 Lloyds Banking Group branches. The Co-op group is planning to offload its non-life insurance business as part of moves to address its deficit. The capital gap is the first to emerge from regulators" analysis of bank balance sheets after the Bank of England's Financial Policy Committee suggested last November that the shortfall across the sector could be up to £50bn. The Financial Services Authority is expected to outline individual deficits in the coming weeks. According to people close to the issue, the Co-op group - which comprises an eclectic array of businesses from funeral planning to supermarkets - is wrestling with a number of potential divestments to bridge its capital gap. As well as the non-life insurance division, its pharmacies business could be sold, bankers said, while further capital could be released through selling off parts of the bank's loan or mortgage book. The Co-op is also close to completing a sale of its life business to Royal London in a deal that should release about £200m. The collapse of the branch purchases plan would create a headache for the majority state-owned bank, which must sell the branches under the terms of an EU state aid ruling. In the absence of a credible alternative bidder, it would be forced to float the unit. There would also be embarrassment for the government. On Monday chancellor George Osborne said he was "very keen" to see the Co-op buy the Lloyds branches. One person with knowledge of the Co-op's plans said a list of options would be presented to the bank's board next month, though three others said it was highly unlikely the Lloyds deal would be kept alive. Mutually owned organisations, such as the Co-op, have limited routes to generate fresh capital and cannot issue equity. Management upheaval at the Co-op has also posed problems, with finance director James Mack quitting last month. Peter Marks, the Co-op group chief executive who was the architect of the Lloyds deal, is also set to retire by May. Two people close to the matter said the bank was hoping to bring in a partner, possibly a fellow mutual organisation from continental Europe, to join the Lloyds bid. "A decision is not far away," said one person close to the matter, adding that the deal itself was capital neutral. This is about having a buffer for downside risk. The Co-op, which reported a 9.6 core tier one capital ratio for the first half of 2012, said its capital levels were above regulatory minimums but declined to comment further other than to say it was still aiming to complete the Lloyds branch deal. Lloyds said: "We are continuing negotiations with Co-op and are making good progress in creating a standalone challenger bank." The FSA declined to comment.