The Financial Services Authority (FSA), the City watchdog, today admitted that it should have warned Northern Rock earlier about the potentially calamitous effects of the mortgage lender's overstretched business model.

Speaking in front of the powerful Treasury Select Committee, Hector Sants, the chief executive of the FSA, emphasised that the board at Northern Rock was in charge of running the company.

However, the regulator, which is coming under intense scrutiny for its handling of the bank's crisis, should have been a more effective policeman.

Mr Sants told the cross-party panel of MPs: “Let’s remind ourselves, it is the board’s responsibility to run the company prudently. But ... we should have been in more intensive discussions with the company earlier."

The management of Northern Rock, led by Adam Applegarth, has been fiercely criticised for chasing market share in the highly competitive mortgage market and making the bank over-dependent on cheap funding in the wholesale market.

But today's admission by the FSA sees the regulator take its share of the blame.

The FSA has previously pointed to its warnings about wholesale borrowing and the beginnings of problems in the funding market.

Mr Sants argued that there was room to modernise the provision of liquidity into the banking system, echoing previous comments made to the same MPs by Mervyn King, the Governor of the Bank of England.

Mr King came under fire last month for the Bank's role in bailing out Northern Rock.

He defended his position that there was a "moral hazard" present in providing emergency funds that might encourage other banks to behave in the same way.

Callum McCarthy, the chairman of the FSA, said today that he disagreed with Mr King over the issue of moral hazard.

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