UPDATE 2-UK financial regulator slams HBOS, waives fine
* FSA says found "very serious misconduct" at HBOS
* Enforcement proceedings linked to HBOS continue
* Report on HBOS failure to come once proceedings completed
LONDON, March 9 (Reuters) - HBOS, now part of Lloyds Banking Group, was censured by Britain's financial watchdog on Friday for failing to control risky lending in the run-up to the financial crisis, escaping a hefty fine to avoid taxpayers being hit twice.
HBOS failed to rein in high-risk loans at its Bank of Scotland unit from April 2008 even as competitors pulled back because of worsening financial conditions, the Financial Services Authority said.
The "very serious misconduct" was also in spite of warnings from the bank's own risk officials and external auditor KPMG, the FSA said.
The watchdog said it had waived the "very substantial" fine HBOS would normally incur as any penalty would be borne by the taxpayer, owner of a 41 percent stake in Lloyds after both it and HBOS were bailed out at the height of the crisis.
"The conduct of the Bank of Scotland illustrates how a failure to meet regulatory requirements can end not just in massive costs to a firm, but losses to shareholders, taxpayers and the economy," the FSA's acting director of enforcement Tracey McDermott said.
The regulator said in a 37-page enforcement notice that it had concluded its enforcement action against the company, but other proceedings linked to the failure of HBOS continue.
The FSA declined to comment.
Once all enforcement actions have been completed, the FSA said it will begin work on a report on the failure of HBOS, as it did with Royal Bank of Scotland, now 80 percent-owned by the state after receiving an emergency cash injection.
Lloyds said it welcomed the FSA's findings.
"This will help to draw a line under the events in question and allow the group to move forward," the bank said in a statement.
Andrew Tyrie, chairman of Britain's parliamentary treasury committee, said, "From what we can tell, corporate governance was a shambles and needs thorough investigation."
"Given the deterrent role of a fine it would also have been helpful if the FSA could have given us an idea of the scale of the fine it would have imposed," Tyrie said.
The FSA's investigation centred on the corporate lending division of HBOS's Bank of Scotland unit, run by Peter Cummings.
The regulator said that for three years ending in December 2008 -- three months after the collapse of U.S. bank Lehman Brothers sent global financial markets into near-meltdown -- HBOS failed to control risks properly as required under FSA rules.
The watchdog said HBOS's corporate unit pursued an aggressive growth strategy with a specific focus on "high-risk, sub-investment grade lending" in the property market.
Markets worsened in 2007, when defaults against U.S. home loans triggered the sub-prime crisis that paralysed interbank lending, triggering a wave of banking failures starting with the collapse of Britain's Northern Rock in September that year.
This did not stop HBOS where the culture of the corporate unit was "strongly focused on revenue rather than on risk adjusted returns."
"Between April and December 2008, the firm failed to take reasonable care to ensure that Corporate adequately and prudently managed high value transactions which showed signs of stress," the FSA said.
The wider group's risk controls failed to rein in the corporate unit where the full extent of stress was "not visible" to the company's board or external auditor KPMG, the FSA said.
The corporate unit did not re-evaluate the growing risks -- which would have forced it to hold bigger capital buffers -- but instead "sought to increase market share as other lenders started to pull out of the markets" in which it operated.
This meant that calculations for the corporate unit's safety buffers "were consistently made at the optimistic rather than the prudent end of the range, despite warnings from the divisional risk function and the firm's auditors".
HBOS, at the time Britain's biggest mortgage lender, agreed to be taken over by Lloyds in a government-engineered deal in September 2008.
In February the following year, Lloyd's had to more than double the level of impairments on its assets to 7 billion pounds from 3.3 billion to take account of bad loans at HBOS.
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