The London City watchdog has been accused of "serious misjudgment" in its failure to step in and block Royal Bank of Scotland's disastrous takeover of Dutch rival ABM Amro.
A report by MPs on the Treasury Select Committee slammed the Financial Services Authority (FSA) for the part it played in the failure of RBS.
The takover saw the UK taxpayer stump up £45.5 billion sterling to prevent RBS from collapse.
The committee said the FSA's biggest fault was not intervening to stop the "calamitous" near £50 billion deal.
It is urging the Government to legislate to ensure the regulator is explicitly required to approve major bank acquisitions to prevent a repeat of the fateful deal.
The FSA comes under widespread criticism in the report, which said its failures in the saga "amount to a serious indictment" of bosses at both the bank and the regulator. The committee also hit out at the FSA for needing to be strong-armed into producing a report into RBS, which was published last December.
The FSA originally decided not to produce a report into the RBS collapse until bowing to Parliamentary pressure.
But the committee found the FSA's report did give a fair picture of events surrounding the bank failure and subsequent bailout.
An FSA spokesman said the regulator would "consider the report's findings and recommendations in detail", adding the FSA had put in place "a completely new model of supervision since the financial crisis".
Today's report said the FSA's inaction throughout the RBS takeover of ABN "reflects a grave weakness in the corporate governance of the FSA".
The FSA did not previously have the power to approve the ABN deal, because it was a takeover of a Dutch bank - but there also was no explicit requirement to give approval even for a deal involving two UK banks.
"It should have intervened at an early stage. It should and could have intervened at a late stage, albeit with more difficulty,'' the report said.
"The FSA's failure to assess the risks of the deal represents a serious misjudgement on the part of the supervisory team and the senior management. We need a regulator with the self-confidence to intervene," it added.
The report also said it was "a matter of considerable surprise" that individuals at RBS were not held responsible, except for Johnny Cameron - former RBS director and chairman of its global banking and markets division - who agreed not to take a top City job again.
RBS made its acquisition of ABN at the height of the boom in 2007, just before the financial crisis struck. The deal weakened its capital position and left it highly vulnerable to the credit crunch.
As well as its £45.5 billion bailout, which has left RBS 80% owned by the State, the bank was also covered by a £282 billion Asset Protection Scheme paid for by the taxpayer. It said this week it was exiting from the scheme, which was originally designed to insure it against losses on toxic assets.
