THE Co-op defended its banking business after a ratings agency said it may need external support to maintain regulatory capital levels.

In a downgrade last night, Moody's said the banks capacity to absorb future losses was now too low to support an investment grade rating.

The Co-op said it was disappointed by the downgrade, which comes less than a month after it pulled out of a deal to buy more than 600 Lloyds branches.

There has been speculation that the Co-op faces a £1bn shortfall in its capital position, although it has been working to address this with the disposal of assets, such as its life and general insurance businesses.

It also announced today that Barry Tootell, who was brought in to lead the banking business through the Lloyds acquisition, had stepped down. He has been replaced by Rod Bulmer, who joined the Co-op six years ago from Santander.

Moody's calculated that the Co-ops problem loan ratio had increased to 10.9 per cent at the end of 2012 from 8.1 per cent in 2011, reflecting a deterioration in its commercial property portfolio. Most of its risks stem from Britannia Building Society, which it acquired in 2009. 

Moody's said the Co-op under-estimated the risks of the acquisition, especially against the backdrop of weak economic conditions.

It added: Moreover, the banks ability to generate the earnings needed to replenish capital, if higher losses materialise, is diminished by its slow progress in realising merger-related revenue and cost benefits.

The Co-op said: "We are disappointed by the ratings downgrade announced by Moody's. We have a strong funding profile and high levels of liquidity, which are significantly above the regulatory requirements. 

"We do acknowledge, like the rest of our banking sector peers, the need to strengthen our capital position in light of the broader economic downturn and the pending introduction of enhanced regulatory requirements, and we have a clear plan to drive this forward throughout the coming months."