The Co-op blamed the current economic environment, the outlook for economic growth and the increasing regulatory requirements on the financial services sector for pulling out of the deal.

Lloyds will now sell the branches as a stand-alone bank through the stock market.

European regulators had demanded the sale of the Lloyds branches – known as project Verde – as part of the deal for being bailed out by the UK government during the financial crisis.

It had been hoped the sale of the branches to the Co-op would have posed a serious threat to the stranglehold of the major high street banks.

Richard Lloyd, executive director of consumer group Which? said: “This is very bad news for everyone wanting to see more competition in retail banking anytime soon.

“The Co-op’s decision is a setback to the Government’s efforts to tackle the unhealthy dominance of our biggest banks. This would have given more choice to consumers who are sick and tired of shoddy service and unfair fees and put more pressure on the big banks to work for customers, not bankers.”

The branches will be rebranded as TSB Bank in the summer and will operate as a separate business within Lloyds Banking Group.

António Horta-Osório, chief executive of Lloyds Banking Group said:
“We are disappointed that The Co-operative Group is unable to complete this transaction. However, we are well advanced in our plans to bring the Verde business to the UK High Street during the summer through the TSB Bank, and will now proceed with the option to IPO the business, subject to the necessary approvals. The TSB Bank will be an attractive retail and commercial bank that will have around 630 branches across the UK, a strong management team and will be a real challenger on the high street.”

In a statement Lloyds said the group is committed to ensuring that the transfer to the TSB Bank is as smooth as possible for customers and will seek to minimise any disruption during this process.