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City to probe how Co-op came to grief with Rev Paul Flowers as police search the former chairman's home over drugs allegations

Prime Minister David Cameron attacks Labour links as Vince Cable reviews scandal-hit bank’s mutual status

The crisis at the Co-operative Bank and the appointment of the disgraced Methodist minister Paul Flowers as its chairman is to be investigated by the Bank of England.

Details of the independent inquiry, which is due to be announced within days, emerged as police searched Mr Flowers’ home in connection with allegations that he regularly used class-A drugs.

The Government has also raised the possibility of the  Co-op being stripped of its name because of the escalating scandal facing the bank.

David Cameron told the Commons that there were “clearly a lot of questions that have to be answered” about Mr Flowers’ appointment at the bank, which came close to collapse when a £1.5bn black hole emerged in its finances.

The bank and its former chairman’s links with the Labour Party have embarrassed the Opposition, which is heavily reliant on the Co-op financially . Also, two years ago, Mr Flowers was forced to resign as a Labour councillor after adult material was discovered on his computer.

The investigation into the Co-op will be carried out by the Prudential Regulation Authority, which is overseen by the Bank of England. It was ordered by Chancellor George Osborne using powers in last year’s Financial Services Act.

A second inquiry into whether the Co-op broke City rules in handling investors’ money could also be undertaken by the recently-created Financial Conduct Authority (FCA). However, neither can be carried out until detectives have completed their investigations into claims that Mr Flowers bought and used illegal drugs including crystal meth, crack cocaine and ketamine.

Mr Cameron announced that Mr Osborne was discussing with financial regulators “the appropriate form of inquiry to get to the bottom of what went wrong here”. He said: “Why was Rev Flowers judged suitable to be chairman of a bank? Why weren’t alarm bells ringing earlier, particularly by those who knew? What we can now see is that this bank, driven into the wall by this chairman, has been giving soft loans to the Labour Party, facilities to the Labour Party, donations to the Labour Party, trooped in and out of Downing Street under Labour, [and is] still advising the Leader of the Labour Party.

“And yet, now we know, all along they knew about his past. Why did they do nothing to bring to the attention of the authorities this man who has broken a bank?”

A senior Labour source responded by accusing Mr Cameron of “a rather desperate political distraction” and said the Coalition faced questions over ministers’ meeting with the Co-op when it was being encouraged to take over Lloyds branches. The Business Secretary, Vince Cable, told the BBC he was considering whether the bank was suitable to bear the name Co-op in the wake of revelations about Mr Flowers.

Use of the word ‘Co-operative’ in a company name requires approval from the Secretary of State on change of ownership, which will happen to the Co-op Bank following its recapitalisation. The Co-op Group has been left with only a 30 per cent stake with the rest held largely by hedge funds.

News that Mr Cable is considering taking such a step – which would be a catastrophic blow to its brand – is yet another headache for an institution facing crisis on multiple fronts.

There are also fears that the scandal could affect its ability to raise capital, while there is a growing clamour among MPs on the Treasury Select Committee to haul in representatives from both the FCA and the Bank of England to answer questions on how Mr Flowers came to be approved as chairman.

The committee’s chairman, Andrew Tyrie, stressed the investigation’s independence was vital. “The authorities cannot be seen to be marking their own work,” he said.

Meanwhile, other mutuals sought to distance themselves from the crisis amid questions over how they are governed.

The Building Societies Association said: “All building societies have voluntarily signed up to the stringent UK Corporate Governance Code which is mandatory only for plcs.”