UK's FSA failed in building society collapse-report

LONDON, July 30 (Reuters) - Britain's financial services regulator failed in its supervisory role in the run-up to the collapse of the Dunfermline Building Society, but ultimate responsibility lay with the lender, a report said on Thursday.

The Financial Services Authority failed to give clear warnings on the risks of commercial lending to Scotland's biggest building society, parliament's Scottish Affairs Committee said in its report on the society's downfall in March.

However, Dunfermline's shortcomings in communicating the risks with its members and certain management decisions, especially in connection with a 9 million pound loss-making IT project, were to blame, the committee said.

"One of the primary concerns for any building society must be effective and transparent communication with its members," the report said.

"This clearly was not the case at Dunfermline Building Society and the anxiety and stress visited upon members as a result of misguided decision-making at board level and what was, at best, miscommunication in its annual report is of serious concern.

"It is also apparent that the FSA failed in its duty adequately to warn Dunfermline of the dangerous path it was taking."

The Dunfermline board told the committee it had diversified away from traditional building society business of loans secured on residential property into commercial lending in response to members' wishes to compete effectively in the market.

After failing to secure a government rescue, Nationwide NAT.UL, Britain's biggest building society, took over Dunfermline's core assets in March in return for a 1.6 billion pound payment from the government.

The report did not comment on whether a capital injection would have been enough to save the building society, but said the Tripartite regulatory authorities, the FSA, Bank of England and Treasury, should review the special resolution regime, the mechanism under which the core parts were transferred.

"It is highly regrettable that the first use of the special resolution regime left the very institution at the heart of negotiations apparently in the dark about the standards which it was expected to meet," the report said.

The Scottish banking sector, already humbled by the bailout of the Royal Bank of Scotland (RBS.L), and shotgun wedding of Lloyds Banking group (LLOY.L) and HBOS, was "dealt a huge blow by the collapse of Dunfermline", the report said.

Dunfermline was Britain's 12th biggest building society.

The main opposition Conservative Party has proposed abolishing the FSA and putting the Bank of England in full charge of supervising financial institutions, an idea the government has called "completely unacceptable".

(Editing by Simon Jessop)