Labour said it was a dark day for banking competition with Chris Leslie, the Shadow Treasury Minister, noting: "This should serve as yet another warning to George Osborne that his economic plan is failing."
Lloyds, Britain's biggest retail bank with more than 2900 branches and part-owned by the taxpayer, now plans to spin off the 632 branches under the TSB name and sell shares in the new company.
Ken Clarke, the former chancellor who now sits in the Cabinet as Minister Without Portfolio, branded the Co-op's statements on why it had pulled out of the deal "bewildering".
"The Co-op appears just to have changed their minds. They have wasted a great deal of time," he said.
A Treasury spokesman stressed the company's decision was "a commercial matter" but made clear the Government remained committed to encouraging challenger banks.
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