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* Regulator warned on Lloyds branches deal -BoE's Bailey
* Regulator had concerns over capital, management -Bailey
* Bailey said Co-op was asked to tell Lloyds about shortfall
* Says he has evidence Co-op did inform Lloyds
* Lloyds had said it was unaware of issues before Dec 2012 (Adds Bailey comments on instructions to Co-op)
By Matt Scuffham and Steve Slater
LONDON, July 2 (Reuters) - Britain's financial regulatorwarned the Co-operative Bank two years ago that itneeded to raise capital and was not in a position to buyhundreds of branches from Lloyds Banking Group.
Andrew Bailey, the Bank of England's deputy governor forfinancial stability, told lawmakers the regulator had seriousreservations about Co-op's ability to acquire 632 branches putup for sale by Lloyds as a condition of its 2008 state bailout.
Bailey said he had raised five issues of concern with theCo-op: capital, liquidity, risk management, integration,governance and management.
"It was a pretty full-set, roughly everything," he said.
Bailey said he believed Co-op had passed on the regulator'sconcerns to Lloyds.
"What I did do is say to the Co-op is it is your duty toinform Lloyds of this and they did, I believe they did. I've noreason to doubt that they did. I have evidence to suggest thatthey did," he told parliament's Treasury Select Committee.
Lloyds executives told the committee last month that theydid not realise there was a problem with Co-op's capitalstrength until December 2012 when a revised plan for theintegration of the two businesses was submitted.
"What we did immediately was to ask the Co-op about it,formally...they did not come formally to us and say, 'We have aproblem'. They came to us and said 'This is the new combinedplan'," Lloyds Chief Executive Antonio Horta-Osorio said.
Peter Levene, who fronted a rival bid from banking venture,NBNK, last month presented a document to the committee that hesays he gave Lloyds chairman Win Bischoff in January 2012,raising questions over why Lloyds was not aware of the issuesearlier.
The document said there was a "high risk" that the Co-op'spurchase of the branches would fall through, citing itsstretched capital position and execution risk.
Despite those concerns, talks between Lloyds and the Co-opcontinued until April this year, when Co-op was found to have acapital shortfall, which the regulator has since identified tobe 1.5 billion pounds ($2.3 billion).
The decision by Lloyds to sell the branches to Co-opprompted allegations that politicians - keen to backcustomer-owned financial services businesses, such as Co-op, asan alternative to mainstream banks - had encouraged the choice.
Lloyds said it was not subject to political pressure andmade the decision to back Co-op's bid for commercial reasons.
Co-op on Tuesday declined to comment on details of the Verdetalks with Lloyds but pointed out that it had since brought in anew management team led by chief executive Euan Sutherland. Thebank had previously said it would review what went wrong whenits restructuring is completed.
Co-op is forcing bondholders to help plug its capitalshortfall shortfall, using a 'bail-in' rescue model which willsee them swap their debt for new bonds and equity in the bank,losing 500 million pounds in the process. (Editing by Louise Ireland)
