Small investors in the Cooperative Bank will have to take a 'haircut' on their high-income bonds as part of a recapitalisation deal agreed between the bank and the regulator set to be unveiled this week.

The Prudential Regulation Authority is said to have assessed the Co-op's capital shortfall at £1.5 billion, and to be satisfied that the bank does not need to look for any further asset disposals.

The group has already agreed to sell its life insurance arm to Royal London for £219 million and its general insurance business is up for sale.

But it means that existing bondholders, including up to 5000 small investors in the former Britannia building society permanent interest-bearing shares, will have their bonds transferred into a new instrument as part of a plan to raise most of the cash.

The £370m of bonds include some £30m held by members of the public, but as they receive annual interest of between 5.55% and 13% there appears scope for rates to be trimmed.

The PRA will say that the new regulator is putting into practice the government's strategy of resolving future bank problems without state aid.

However, the Co-op is said to have drawn down almost £1bn from the Funding for Lending Scheme, at the same time as turning off its supply of funding to small business.

At the end of April the Co-op pulled out of the £750m deal to buy 632 branches from Lloyds and a fortnight later, ratings agency Moody's downgraded the bank's debt to "junk" status.