A WHISTLEBLOWER has exposed how Britain’s financial watchdog allowed banks to influence the bonuses and career prospects of its staff.

The Financial Services Authority (FSA), which presided over the banking collapse, gave financial institutions a formal role in determining the pay of the very regulators tasked with overseeing them. The disclosure unmasks the cosy relationships created when Gordon Brown swept away the Bank of England’s supervisory role in 1997, paving the way for the excesses of the credit boom to grow unchallenged.

The whistleblower, a former FSA official, turned to Michael Fallon MP, deputy chairman of the Commons Treasury committee, to shine a light on the close ties between the watchdog and the banking industry.

Fallon has said that allowing banks to report on the FSA’s staff is “monstrous” and has attacked Hector Sants, chief executive of the City watchdog, who dismissed the allegations when quizzed on the procedure last month. “This practice perfectly illustrates how the City watchdog became a lapdog to the banks,” Fallon said.

Recent claims to the committee by another whistleblower, Paul Moore, that he had been sacked after warning about excessive risk-taking at HBOS, led to the resignation of Sir James Crosby as deputy head of the FSA. Crosby was previously chief executive of HBOS.

The latest whistleblower, who has provided evidence to The Sunday Times, said financial institutions are asked for “feedback” on FSA staff charged with supervising them.

The comments are considered for appraisals used to decide pay and bonuses. Fallon said the system was a “disincentive” to challenge the banks.

The whistleblower claims: FSA staff were anxious not to antagonise the banks because of the potential impact on pay. The FSA’s regulatory staff were warned “not to frighten the horses” during visits to financial institutions because it relied on their cooperation. The FSA ethos was that it was “to serve” the industry which fully funded it. Staff turnover and lack of resources meant there was insufficient FSA expertise to question the strategies of the big banks.

“The FSA was in thrall to the industry,” said the insider. “The consensus was you don’t rock the boat. If a firm complained, you could get marked down on your appraisal. It was deluded and immoral.”

The whistleblower said staff received bonuses of between 1% and 15% of salary. Good reviews from the institutions they supervised could help.

The FSA’s staff assessment form includes “positive feedback from firms” as a performance indicator. The whistleblower said it reflected a culture in which there was a reluctance to challenge the banks.

“It was felt that unless there was trust between the FSA and the companies, they [the FSA] would never be told anything. The problem was they didn’t have the proper resources to find out for themselves.”

Fallon challenged Sants, the FSA chief executive, over his staff appraisal scheme at a select committee hearing last month, warning that any feedback from firms for appraisals might act as a “strong disincentive” to robust regulation.

Sants appeared to suggest that financial firms provided feedback only for staff in non-supervisory roles.

But on Friday the FSA confirmed that “all supervisory staff are subject to feedback”. A spokeswoman said: “The firms should be able to provide feedback on how well you are doing your job as a supervisor. It has an impact on everything relating to that member of staff.”

The FSA insisted feedback played only a small part in pay appraisals. Other indicators were also used, such as peer review and specific objectives.

“The performance of supervisors will be far more negatively assessed if they do not challenge firms appropriately. The entire culture of the FSA is to encourage supervisors to be extraordinarily robust,” the spokeswoman said.

“It is entirely appropriate that stakeholders should be asked for their views. It is completely untrue that this would be a disincentive to challenge firms. If they got negative feedback, their manager would have the wit to realise the firm was being partial.”

She denied any suggestion that the FSA’s relationship with financial firms had been too close: “We do not serve the firms. We are there to protect consumers and promote efficient and orderly markets.”

The FSA said it had acknowledged weaknesses in its supervisory processes in the past but now considered it was very robust in challenging and supervising financial firms.

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