KPMG has robustly defended its work as auditors to the Co-operative Bank, saying its due diligence ahead of the bank's merger with Britannia was 'thorough', although it was unable to examine the building society's loss-making corporate loan book which was a major factor in the bank's subsequent £1.5bn shortfall.

Appearing before a Treasury select committee, KPMG audit partner Andrew Walker said there was nothing in the due diligence work carried out by the firm, which has audited the Co-op Bank for thirty years, to indicate the scale of the future problems. KPMG was paid a total of £1.3m by the Co-op for its work on the Britannia merger, including £841,000 for its due-diligence report.

Walker told the committee that the Co-op and KPMG agreed on ten risk factors which the firm investigated, but it was not asked to review Britannia's commercial loans. In evidence, Walker said that Britannia 'did not have the capability to have people coming in to the premises' to look at the corporate loan book and had 'confidentiality and sensitivity issues' about handing over the details. Problems in this area accounted for most of the £550m Britannia-related losses that the Co-op reported this year.

KPMG gave the bank a warning about growing impairments in other parts of Britannia's loan book and recommended that the Co-op should investigate Britannia's corporate loans. The bank went out to do own due diligence in this area and Walker told the committee that the Co-op's management in general seemed competent and 'asked the right questions'.

However, Walker also told the committee that he had asked the Co-op's chief executive to 'substantially' re-write parts of the bank's 2012 full-year statement to take out overly-optimistic remarks.

'We asked for a rewrite because they were not reflective of the circumstances in the accounts. We asked that optimistic references to strength in the bank overall were removed. What was left were references to the liquidity position of the bank and the core bank being the strong areas of the bank. Those two statements were consistent with the projections I was seeing as part of the audit for the core bank which was profitable and the capital and liquidity positions of the bank,' Walker said.

In his evidence, Walker said KPMG's due diligence report contained warnings in connection with rising arrears in the non-conforming mortgage book of Britannia, as well as highlighting Treasury assets of £100m to weak counterparties and some of the risks inherent in the securitisations that Britannia had that could trigger defaults. He said the Co-op 'absolutely' accepted the firm's advice.