The Financial Services Authority has admitted ‘flaws’ in its own supervisory approach played a part in the failure of Royal Bank of Scotland and provided insufficient challenge to the firm.

In its 452-page report into the failure, released today, the FSA says it was too focused on conduct regulation and its prudential supervision of major banks was ‘inadequate’.

Chairman of the FSA, Lord Turner, stated: “The FSA operated a flawed supervisory approach which failed adequately to challenge the judgement and risk assessment of the management of RBS.

“This approach reflected widely held, but mistaken assumptions about the stability of financial systems and existed against a backdrop of political pressures for a ‘light touch’ regulatory regime.”

It also conducted little analysis of RBS’s underlying asset quality and underestimated the effect of structured credit losses.

As a result the FSA will be split into the Prudential Regulation Authority and the Financial Conduct Authority next year.

It has also established the Financial Policy Committee to identify emerging systemic risks.

Lord Turner said: “The creation of the PRA, focused exclusively on prudential issues rather than spanning both prudential and conduct concerns, and of the FPC, will ensure that focus on prudential and systemic risk is maintained even when most of the world assumes, as it did before the crisis, that prudential risks are low."

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