Politicians may have become too fascinated by the apparent expertise of financiers and bankers, the head of the financial watchdog said yesterday.

While accepting the shortcomings of the Financial Services Authority in failing to anticipate the credit crunch, Lord Turner of Ecchinswell allowed himself to be drawn on the question of whether ministers, including Gordon Brown, had got too close to the banks.

Mr Brown is reputed to have helped to broker the controversial Lloyds-HBOS merger in a chat with Sir Victor Blank, then Lloyds TSB chairman.

Interviewed on The Andrew Marr Show on BBC One, Lord Turner said: “Over the last ten years there probably was too much of a fascination with what you could call finance capitalism, and a failure to realise the risk that was emerging. Perhaps at the end of it there will be less fascination.”

He admitted that the FSA had failed to recognise adequately the risky way in which banks were developing.

He said that his review of regulation, due on March 18, would propose “major changes” to requirements on capital and the regulation of liquidity, as well as bringing “shadow banks” under FSA oversight. The report will also look at pay structures and credit rating agencies and will reinforce the FSA's supervisory processes.

The FSA, created by Mr Brown in 1997, when he removed responsibility for overseeing banks from the Bank of England, has been criticised widely for its failure to predict and prevent the crisis. Lord Turner, who was appointed its head last September, said that regulators around the world had failed to recognise that by 2004 the banking system was developing in a way that created a “large systemic risk”.

“We didn't focus enough on that – the FSA, the Bank of England, the Treasury, the Fed and OCC [Office of the Comptroller of the Currency] in the US didn't focus enough on these issues and we have got to get that right in the future,” he said.

It was a “legitimate criticism” of the FSA that it had focused on the detail of individual banks' processes without standing back and recognising that the growth of credit was too risky.

“With hindsight, the FSA, like other authorities throughout the world, was focused too much on individual institutions and the processes and procedures within them, and not adequately focused on the totality of the systemic risks across the whole system and whether there were entire business models, entire ways of operating, that were risky,” he said. “That's with hindsight, but remember it is with hindsight and there weren't many people who got it right at that time.”

Lord Turner said that the FSA would pay staff bonuses this year, equivalent to about 15 per cent of their salaries. Reports suggest that the bonus bill could reach £33 million. One member of the FSA who had refused a bonus is Hector Sants, the chief executive. He was paid £662,000 last year, including a £114,000 bonus.

Lord Turner rejected suggestions that FSA staff should forgo bonuses: “We are going to be paid bonuses,” he said. “The FSA has developed a process of having an element of variable pay. People have joined on that basis.

“If you are saying we should now cut the bonuses, you are saying we should cut their pay by 15 per cent. That's against a background where we are being told we need better people.”

Asked if he would apologise for the FSA's failings, he said: “I am certainly sorry that across the whole world there was a failure to focus on those systemic risks and it was an intellectual failure ... The FSA was doing a lot of good work in many aspects, but it, like others, failed to focus on those wider systemic issues. And there are very, very deep issues about how we get it right for the future.”

Kenneth Clarke, the Shadow Business Secretary, said there had been a “complete failure” of the tripartite structure of the Bank of England, the FSA and Treasury. He told Sunday Live on Sky News: “Gordon destroyed the previous system. We don't know whether that would have worked but the one he put in place was useless, totally useless, and it is important to get back to regulation. The FSA had adopted a “box-ticking” approach: “The banks were being regulated but in a less important way, on process. It was box ticking. What they were not being regulated properly on was the big risks they were taking.”

Vince Cable, the Liberal Democrats' Treasury spokesman, said that there had been shortcomings at the FSA. “One of the embarrassing features of the City is that you have people in the big investment banks paid an absolute fortune, and people, public servants in effect, looking after the banks in a much weaker position,” he told the BBC.

“Now that we have a very deep financial recession you are going to find a lot of heavily qualified bankers queueing up for jobs as regulators and that will make the balance between the poachers and the gamekeepers a bit more even.”

Lord Turner of Ecchinswell

Born October 5, 1955; son of Geoffrey Vincent Turner and Kathleen Margaret

Married 1985, to Orna Ni Chionna; two daughters

Education Hutchesons’ Grammar, Glasgow; Glenalmond school; Gonville & Caius College, Cambridge

Career began at BP, in corporate planning, 1979; McKinsey, 1982-85; Director-General of the CBI, 1995-99. Has chaired the Pensions Commission, the Low Pay Commission and the Economic and Social Research Council. Elevated to the Lords in 2005 as a crossbencher. In September 2008 he became chairman of the Financial Services Authority

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