CO-OPERATIVE Group has dropped plans to sell its general insurance arm while accountancy watchdog the Financial Reporting Council has launched an investigation into Big Four firm KPMG's oversight of its banking arm's accounts.

The mutual, led by Scottish-born chief executive Euan Sutherland, has come under pressure after an attempt by Co-op Bank to buy a portfolio of bank branches, including Lloyds TSB Scotland, unravelled last year and it emerged the division had a £1.5 billion capital shortfall.

Co-op said yesterday it no longer needs to sell its general insurance arm, which sells products such as car and home insurance, because of changes to the recapitalisation plan for Co-op Bank. This has led to the group putting up less money but with control passing to a group of bondholders led by US hedge funds.

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Mr Sutherland, who ran Kingfisher's do-it-yourself business B&Q before joining Co-op in May, said: "Having considered the sale process, and in light of the changed requirements on us under the bank recapitalisation process, we believe it is in the best interests of our members, customers and colleagues, that we retain this strong business and develop it further.

"We received a significant amount of interest in the general insurance business, which reflects its potential."

The insurance business had been put up for sale in March. Its sale had been expected to raise hundreds of millions of pounds for Co-op with potential bidders including investment giant Legal & General, private equity firms AnaCap and Advent International, and industry consolidator Catalina Holdings.

Co-op originally planned to put up around £1bn of capital to stabilise its bank. This has now dropped to around £500 million due to a debt-for-equity swap that will see bondholders assume control of 70% of the business. The mutually owned group said that in reaching its decision to retain the insurance business managers had "taken into account the general insurance business's significant growth potential".

Co-op will meet its capital commitment to the bank in part with the £219m sale of its life and savings business to Royal London which completed in August. The rest of the money will come from measures including the "strategic management" of some of its properties, Co-op said.

The sudden plunge in the Co-op Bank's financial strength last year has led to politicians questioning the role of KPMG which was responsible for auditing its accounts, including those for the 2012 financial year just months before Co-op revealed its capital problems.

The FRC's investigation will be followed by a decision about whether to bring disciplinary proceedings against a firm or individual. This would then require a tribunal hearing before any sanctions or costs orders were made.

The Bank of England's Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) are conducting separate inquiries into the problems at the bank.

A planned probe by the Government has been put on hold.

The Treasury Select Committee is also looking at the matter.

Today MPs will quiz representatives from NBNK, whose bid for the Lloyds branches was trumped by Co-op.

A KPMG spokesman said: "Given the issues which the bank has experienced in recent months and in the light of the high media profile and public interest associated with these issues, it is understandable that there should be appropriate regulatory scrutiny."

The firm said "it is to be expected" that there would be scrutiny of the audit but insisted that "the auditor is independent of the events which gave rise to the issues experienced by the bank".

"As auditor to the bank we believe that we have provided, and continue to provide, robust audits which provide rigorous challenge to the judgements and disclosures proposed by the bank's management," the spokesman said.

The firm said it would co-operate fully with the investigations being pursued by the FRC and other regulators.

There has been a dispute between regulators and former Co-op chief executive Neville Richardson about whether Co-op's problems stem from the property loans it inherited on its 2009 merger with the Britannia building society he previously ran.