MPs have accused the Financial Services Authority (FSA) of a "substantial failure of regulation" over its handling of the Northern Rock crisis.
The financial watchdog has admitted clear warning signals existed before interbanking lending difficulties led to last September's run on the struggling bank, according to a report out today.
MPs on the Commons' Treasury select committee say the FSA's attempts at greater regulatory engagement failed to tackle the fundamental problems of Northern Rock's banking model, leading them to conclude "the current regulatory regime for the liquidity of UK banks is flawed".
Their report says the FSA failed to secure remedial action from Northern Rock's board, was wrong to allow the board's two senior members being appointed without "relevant financial qualifications" and failed to "supervise" the lender properly.
'All of our customers are international and we need those transport links to be as efficient and effective as possible'
'Because key gateways have been capacity constrained, a lot of freighter services now terminate in mainland Europe'
Also coming under attack is the Bank of England, which should have been "more proactive" in its response to troubled global financial markets in August.
And delays in the decision to end the run on Northern Rock by providing a guarantee for depositors were caused by a lack of forward planning condemned as a "serious error of judgment".
The report concludes: "The events surrounding the crisis at Northern Rock have been damaging to the financial services industry in the United Kingdom, and for the tripartite authorities.
"It is important that the lessons are learned from this crisis, and that the changes that result from this process are implemented swiftly, given the continuing problems in the world's financial markets and the desirability of ensuring that the damage to the UK's reputation as a financial centre is minimised."
It backs the establishment of a new head of financial stability at the Bank of England who will be tasked with dealing with similar problems in the future
Conservative shadow chancellor George Osborne pointed out the Treasury committee was dominated by Labour MPs but still attacked chancellor Alistair Darling's "lack of leadership".
"Thanks to his economic incompetence over Northern Rock, Alistair Darling's credibility is in shreds," he said.
Mr Osborne also noted the report recommended handing power to rescue stricken banks to the Bank of England and not the government, as Mr Darling advocates.
"Conservatives first suggested this before Christmas," he added.
"Alistair Darling should do another U-turn on his misjudged policy before he makes yet another serious error of judgement."
Liberal Democrat spokesperson Vince Cable said the FSA had done nothing to "rein in" Northern Rock's board, which he said had acted "like a bunch of cowboys".
"The FSA's inaction has not only destroyed the credibility of Northern Rock, but has also seriously damaged confidence in the wider economy," he commented.
"We need procedures for more active controls of bank lending, relying not only on interest rates but also capital adequacy requirements to prevent unsustainable growth in lending."
The Treasury was not immediately available for comment.