The UK blew a chance to create a major new player in the banking industry because a black-hole in the Co-op Bank's finances was not spotted by regulators and its auditor until it was too late, MPs said yesterday.

A report by the Treasury Select Committee is critical of the work of KPMG and said problems at the mutual should have been identified long before the Co-op's ill-fated £750 million bid to buy 632 branches from Lloyds Banking Group.

But MPs said they found no evidence that politicians swayed the 2012 decision by Lloyds to choose the Co-op over rival bidder NBNK Investments.

The takeover collapsed after a huge shortfall of £1.5 billion was discovered in the mutual's balance sheet, causing Lloyds to trigger a fall-back option of a stock market listing under the TSB brand.

Committee chairman Andrew Tyrie said: "Each of the backstops - Co-op Bank itself, KPMG as its auditor, and the FSA as its regulator - failed to uncover the bank's capital shortfall until it was too late.

"Each had a hand in this sorry tale. But by far the biggest responsibility lies with the Co-op Bank leadership."

Mr Tyrie said the divestment should have been an opportunity to establish a significant new challenger in UK retail banking but that this opportunity was lost because of the late discovery of the Co-op Bank's problems.

TSB's market share of 4.2% raised questions about whether the new entity was large enough to act as a significant challenger in the market, he added.