UPDATE 2-Co-op paves way for Lloyds deal with disposal plan
* Plans to sell general insurance business to bolster finances
* Co-op has agreement in place to buy 632 branches from Lloyds
* Co-op CEO says 'still a lot of work to do' to pull off deal
* Co-op CEO says tough economic backdrop hindering progress
* Co-op Bank makes 2012 loss of 674 mln stg
By Matt Scuffham
LONDON, March 21 (Reuters) - The Co-operative, Britain's largest mutually-owned business, paved the way for the purchase of 632 bank branches from Lloyds as it announced on Thursday that it planned to sell its general insurance arm to bolster its finances.
Lloyds must sell the branches, code named Verde, as a condition of receiving state aid during the 2008 financial crisis and the two parties said last June they had reached an understanding of the terms of a deal which would create a new competitor to Britain's established high street lenders.
Co-op has agreed to pay Lloyds up to 750 million pounds ($1.13 billion) for the branches, but issues relating to computer systems, funding and the tough economic backdrop have made the deal difficult to execute. Co-op's Chief Executive Peter Marks told reporters that there was "still a lot of work to do" to pull it off.
"We're trying to conclude this transaction in very difficult economic times. That's what makes it more difficult. We're trying to establish what the risks are and to mitigate those risks," Marks told reporters on a conference call.
Marks said that the deal continues to "make sense" strategically both for Co-op and for the UK banking sector. Lawmakers and regulators are examining ways to create competitors for Britain's 'big four' banks - Lloyds, RBS , HSBC and Barclays.
The Verde business has around 5 million customers and represents 6 percent of all bank branches in Britain. When combined with the Co-op's existing bank business, it would have 7 percent of the total market for current accounts in Britain.
Co-op, which also has businesses including supermarkets, funeral management, travel and pharmacy, is looking to raise capital to help facilitate the deal and the planned sale is in addition to the announced sale of its life insurance business to Royal London Mutual Insurance for 219 million pounds.
"We're getting in shape to do it if we can. We're clearing the decks in order to take advantage of the Verde acquisition if we decide to go ahead with it," Marks said.
Lloyds said earlier in March that it was preparing for a stock market listing of the branches as a fall-back should the deal with the Co-op fall through.
Marks declined to comment on whether Co-op had had any approaches for its insurance business.
Sky News reported on Wednesday that British bid vehicle Tungsten Corporation, headed by financier Edmund Truell, was considering a 600 million pound offer.
The overall Co-op business, including the group's retail arm, reported an underlying operating profit of 431 million pounds in 2012, down from 523 million pounds the year before as the UK recession continued to bite.
Co-op bank made an operating loss of 281 million pounds and a statutory, or a reported loss of 674 million pounds, hit by a further charge of 150 million pounds to compensate customers mis-sold insurance on loans and mortgages. It has now set aside 244 million pounds in total to deal with the issue.
Co-op said its losses on bad loans had risen to 474 million pounds during the year from 121 million the year before. It said that reflected the strains on its customers' ability to pay back money, particularly in the corporate sector.
Marks said he didn't expect to see any significant recovery in the British economy during 2013.
The group's food retail business made an operating profit of 288 million pounds, down from 318 million the year before.
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