The Cabinet Office said the award had been "cancelled and annulled".
David Cameron tonight hailed the decision to remove Fred Goodwin's knighthood.
The Prime Minister said a key report into the failure of Royal Bank of Scotland had made clear "where the failures lay and who was responsible".
"The proper process has been followed and I think we've ended up with the right decision," he said.
The award was "cancelled and annulled" by the Queen after a key committee found the ex-banker had brought the honours system into "disrepute".
A spokesman for Deputy Prime Minister Nick Clegg said: "It is the right decision."
Mr Goodwin received his knighthood for services to banking under the Labour government, before leading RBS to the brink of collapse in 2008.
Honours are usually only removed from individuals who have been convicted and jailed.
But announcing the move this evening, the Cabinet Office said the scale of the RBS disaster - necessitating a £45 billion bail-out from the taxpayer - made the case "exceptional".
"Both the Financial Services Authority and the Treasury Select Committee have investigated the reasons for this failure and its consequences," the department said in a statement.
"They are clear that the failure of RBS played an important role in the financial crisis of 2008-9 which, together with other macroeconomic factors, triggered the worst recession in the UK since the Second World War and imposed significant direct costs on British taxpayers and businesses.
"Fred Goodwin was the dominant decision maker at RBS at the time.
"In reaching this decision, it was recognised that widespread concern about Fred Goodwin's decisions meant that the retention of a Knighthood for 'services to banking' could not be sustained."
The Forfeiture Committee, made up of senior civil servants, met last week to consider the issue.
Its recommendation to strip Mr Goodwin of the honour was conferred to the Queen by David Cameron.
The Cabinet Office said: "This decision, not normally publicised in advance, was taken on the advice of the Forfeiture Committee, which advised that Fred Goodwin had brought the honours system into disrepute.
"The scale and severity of the impact of his actions as CEO of RBS made this an exceptional case."
In his statement, Mr Cameron said: "I welcome Forfeiture Committee's decision on Fred Goodwin's Knighthood.
"The FSA report into what went wrong at RBS made clear where the failures lay and who was responsible."
Labour leader Ed Miliband told Sky News: "I think it's only the start of the change we need in our boardrooms.
"We need to change the bonus culture and we need real responsibility right across the board.
"I think that is what the public want, I think that is what government working with the private sector needs to deliver."
Here is the full Cabinet Office statement on Fred Goodwin's knighthood:
It will soon be announced in the London Gazette that the Knighthood conferred upon Fred Goodwin as a Knight Bachelor has been cancelled and annulled.
This decision, not normally publicised in advance, was taken on the advice of the Forfeiture Committee, which advised that Fred Goodwin had brought the honours system in to disrepute.
The scale and severity of the impact of his actions as CEO of RBS made this an exceptional case.
In 2008 the Government had to provide £20 billion of new equity to recapitalise RBS and ensure its survival and prevent the collapse of confidence in the British banking and payments system. Subsequent increases in Government capital have brought the total necessary injection of taxpayers' money in RBS to £45.5 billion.
Both the Financial Services Authority and the Treasury Select Committee have investigated the reasons for this failure and its consequences. They are clear that the failure of RBS played an important role in the financial crisis of 2008-9 which, together with other macroeconomic factors, triggered the worst recession in the UK since the Second World War and imposed significant direct costs on British taxpayers and businesses. Fred Goodwin was the dominant decision maker at RBS at the time.
In reaching this decision, it was recognised that widespread concern about Fred Goodwin's decisions meant that the retention of a Knighthood for "services to banking" could not be sustained.
PA
