The Co-operative Bank is facing a capital hole of up to £1bn which could scupper its plans to buy 600 branches of Lloyds Banking Group.

To bridge its capital gap, the Co-op group is planning to sell its non-life insurance division and pharmacies business apart from selling off parts of its loan.

The Manchester-based commercial bank is considering selling its non-life insurance business. Meanwhile, the Co-op is close to close a sale of its life business to Royal London in a deal worth around £200m.

Under the terms of an EU state aid ruling, the Co-op must sell its branches. The Co-op, which will propose a list of options to its board in March, may also include a partner from continental Europe to join the Lloyds bid.

Lloyds said: “We are continuing negotiations with Co-op and are making good progress in creating a standalone challenger bank.”

George Osborne said he was very keen to see the Co-op buy the Lloyds branches.

Peter Marks, chief executive of the Co-op group, is set to retire by May 2012, while finance director James Mack resigned last month.

The Co-op said its capital levels were above regulatory minimums.