UPDATE 3-UK watchdog admits approval of ex-Co-op Bank chairman was mistake
* FCA's Adamson says decision was not a mistake at the time
* Adamson admits in hindsight appointment was wrong
* Appointment approved after single 90-minute meeting
* TSC Chairman Tyrie says regulator "negligent ... very poor"
* Says there were "fundamental flaws" in processes
By Matt Scuffham and Huw Jones
LONDON, Jan 7 (Reuters) - Approving local councillor Paul Flowers as chairman of Britain's Co-op Bank was a mistake but only with the benefit of hindsight, the regulator who played a key role in the appointment conceded on Tuesday.
Flowers, also a Methodist minister who was arrested in November as part of an investigation into the supply of illegal drugs, had no banking qualifications but had been given the job following a 90-minute interview with Britain's banking regulator.
Flowers had left the bank - favoured by customers for its perceived ethical stance - last June, but subsequent events including its rescue by bondholders became one of Britain's biggest financial scandals of the past year.
Appearing before parliament's Treasury Select Committee, Clive Adamson, director of supervision at the Financial Conduct Authority (FCA) watchdog, initially said he had no regrets over the decision to approve Flowers, before admitting lessons needed to be learned.
"With the benefit of hindsight, yes I do think we got it wrong, but it was the right decision at the time," Adamson said.
The Co-op Bank's shortcomings have also raised fresh questions about how banks are regulated, still a hot topic nearly seven years after the start of the financial crisis which exposed big deficiencies in scrutiny of the sector.
Adamson said Flowers would not have been approved by the regulator today as it now insists on potential bank chairmen having a background in financial services.
After the session, Committee Chairman Andrew Tyrie said Adamson's evidence showed fundamental flaws in the way regulators previously assessed candidates for senior banking roles.
"These flaws contributed to the appointment of a man with no knowledge of finance and no experience of running the board of a major corporation as the chairman of Co-op Bank in the immediate aftermath of the financial crisis," Tyrie said.
The government has subsequently passed laws scrapping the regulator's "approved persons" regime and replacing it with tighter rules over the appointment of senior bankers.
Flowers' arrest ramped up pressure on the 141-year-old lender, which has fallen under the control of bondholders including U.S. hedge funds following a 1.5 billion pound ($2.5 billion) rescue.
Adamson was grilled for more than two and a half hours, an hour longer than he interviewed Flowers in 2010 to decide he was competent enough to chair the bank. He was repeatedly pressed by members of the committee to admit that approving the appointment was a mistake.
Tyrie said the regulator's decision to put a "financial illiterate" in charge of its board was a "negligent decision, a very poor decision".
Britain's financial regulators have launched an investigation into problems at the bank and the probe could lead to fines for the bank and its former directors.
The investigation may also prove a test case for new rules being introduced in Britain which mean bankers who are reckless with customers' or taxpayers' money could face criminal charges and have bonuses and pensions clawed back.
Adamson said he was disappointed that at no time did anyone from the bank or public life alert the regulator about some of Flower's alleged misdemeanours.
Flowers had been interviewed by regulators in 2009 when he joined the Co-op Bank board as a non-executive director. A year later he became non-executive chairman.
Before the Co-op Bank appointment, Flowers had been a local councillor and was influential in the political wing of the Co-op movement. He did not boast any experience of leading boards of either banks or other businesses.
Adamson said it was then a "somewhat unruly board" of 22 members and that it was important to have someone in place to better chair it.
"My view was that Flowers did have the competence to perform the role of non-executive chairman," Adamson said. "Our view is that a non-executive chairman does not run the bank but run the board."
Adamson said he went beyond what was required by meeting Flowers in 2010 when he was appointed chairman to secure agreement to appoint two deputy chairmen with financial experience. He acknowledged that parts of the 2010 interview with Flowers were a "box-ticking" exercise.
Adamson ran the major retail groups division at the Financial Services Authority, before becoming director of supervision at the FCA when it replaced the old body.
During Tuesday's tense evidence session, his judgement came under questioning, with Conservative lawmaker Andrea Leadsom challenging whether he was fit to stay in the job
"I believe that I am the right person," he responded.
Adamson told the committee that the regulator had been aware Flowers had a criminal conviction from 1981 for gross indecency but decided it was not relevant to his appointment. He said the regulator was not aware of an additional drink-driving conviction in 1990.