The Co-operative Bank is to have its shares listed on the stock market for the first time as part of a deal to plug a £1.5bn capital shortfall and stave off nationalisation after its troubled merger with Britannia Building Society four years ago.

As a result of an agreement hammered out with the Prudential Regulation Authority, the bank's bondholders – including 7,000 private investors – will be asked to take losses in return for shares in a move that has raised concerns about the future of the co-operative movement and the bank's ethical ethos.

Although the bank was already a public limited company owned by the Co-operative Group – the country's biggest mutual, which owns grocers, funeral homes and pharmacy chains – it will end up with shares listed on the stock exchange under a complex "bail in" of bondholders in October.

The "bail in" is a new, largely untested method for helping banks raise capital and will allow the Co-op to avoid having to raid other parts of its business. It is the route the authorities are now adopting, after the wave of taxpayer bailouts in2008-09.

The bank, which has 4.7 million customers but has stopped lending to businesses, had run low on capital after incurring losses on commercial property loans largely granted by Britannia before the 2009 merger between the two organisations. Some £14.5bn of loans, largely granted by Britannia, have been put into a non-core bad bank to be sold off or run down.

Until April, Co-op had been in talks to take over 632 branches from Lloyds Banking Group, which would have put more capital into the enlarged bank. Lloyds' bosses will appear before the Treasury select committee of MPs on Tuesday to face questions on this so-called Verde deal, which the government had hoped would inject more competition into a high street dominated by the big four banks.

The Co-op has installed new management at group level and at the bank but on Monday none would discuss the past. However, the new chief executive of the bank, Niall Booker, conceded that the capital-raising exercise would probably not have been needed if the Britannia deal had not taken place. Booker, a former HSBC executive, started last week. His predecessor left in May after ratings agency Moody's downgraded the Co-op's investment rating to junk status.

"It's apparent that with the Britannia deal came some bad loans that needed to be worked out and it's equally apparent that the franchise strength lies in the retail and SME [small and medium enterprises] segment of the Co-op," Booker said.

Euan Sutherland, the former B&Q boss who has been chief executive of the overall Co-op Group for six weeks, refused to say whether bonuses would be clawed back from departed directors. "The time will come when we are able to look back at what happened," he said.

The newly installed group finance director, Richard Pennycook, hired from supermarket chain Morrisons, was reluctant to stand by accounts issued by the bank. "We'll take the fifth amendment on that," said Pennycook, who added that an important step was being taken to solve a "pretty unstable" situation.

Some 5% of the bonds affected – some of which pay 13.5% interest – are held by retail investors, whose average investment was £1,000 each. The precise detail of their losses will not become clear until full details of the "exchange offer" are published before October, when the shares will be listed in London.

The abortive deal with Lloyds helped shed light on the scale of the Co-op's problems. When Lloyds chief executive António Horta-Osório and chairman Sir Win Bischoff give evidence to MPs on the episode on Tuesday they may face questions about government interference after a Conservative MP, David Davis, wrote to the Times saying the Treasury should explain its role. Mark Hoban, City minister at the time, is known to have held 30 meetings to smooth the deal.

Despite assurances by the Co-op that the deal would not affect its approach to business and customers, Andre Spicer, professor of organisational behaviour at Cass Business School, said the bail in was a profound change in the business model of the bank.

"This change is likely to clash with the co-operative ethos of the bank and, in the longer term, this might undermine what has made the Co-op attractive to its staff and customers," Spicer said.

Once the bank's shares are listed on the stock market, the Co-op Group will retain a majority holding of around 75%. The Co-op Group will contribute £1bn to bolster the bank – some £500m through selling off insurance businesses and another £500m by issuing bonds to existing bondholders. The bank's bondholders will raise the other £500m through the exchange offer while the bank has until the end of the year to reach a higher capital threshold than rivals of 9%.

The results of an industry-wide exercise by the PRA, which uncovered a £25bn capital shortfall, will be published on Thursday.