FSA is set to investigate former chief over HBOS supervision

Crosby also 'headed bank for some of relevant period' ahead of near collapse

The City watchdog is to investigate whether its former deputy chairman Sir James Crosby had an "undue influence" on its oversight of HBOS in the run-up to the bank's near collapse, it emerged last night.

Sir James joined the board of the Financial Services Authority in January 2004, and became deputy chairman there in 2007, having been appointed by Gordon Brown when he was Chancellor of the Exchequer. Mr Brown has previously told the Treasury Select Committee that he took "full responsibility" for the appointment.

Sir James was still chief executive of HBOS at the time he joined the watchdog's board and did not step down from the bank until 2006 when he was replaced Andy Hornby, the former retailer who was in charge of the bank when it had to be rescued by Lloyds Banking Group in a deal brokered by Mr Brown's government.

Summary minutes of the watchdog's September meeting reveal that directors discussed the fact that Sir James, "the previous deputy chair of the FSA" had been "CEO of HBOS for part of the relevant period" and that the report "needed to address any perceived influence of his position on the FSA's supervision of HBOS".

Sir James's role at the FSA became hugely controversial after allegations that he had sacked HBOS's former head of risk Paul Moore, who in 2003 and 2004 argued that the bank was exposed to too much risk.

Mr Moore's arguments centred on concerns about borrowers' ability to repay loans rather than wholesale lending markets shutting down, which left the bank fatally exposed and led to its rescue by Lloyds. Mr Moore's dossier of complaints was originally investigated by KPMG, the City accountancy firm and former HBOS auditor, which concluded that HBOS did in fact have appropriate risk controls in place at the time. This was originally accepted by the Financial Services Authority.

Sir James resigned from his role at the FSA to protect it from mounting criticism after the news that Mr Moore had raised concerns about the bank's risk profile broke.

Were the report to find that Sir James had exerted any influence over the supervision of HBOS it could ignite a powder keg and draw Mr Brown in, although there is no suggestion that this is the case.

The analysis of the FSA's conduct will be carried out by Grant Thornton after all the "big four" accounts, which include PricewaterhouseCoopers, Deloitte and Ernst & Young in addition to KPMG declined the work citing conflicts of interest.

Board members also discussed the fact that the report will likely prove to be more expensive than a similar probe into the collapse of Royal Bank of Scotland. Costs will be met by Lloyds Banking Group as HBOS's owner.

The report is not expected to see the light of day until next summer. It was commissioned after Peter Cummings, who led the bank's commercial lending arm, was fined £500,000 and banned from the City, bringing to an end the only disciplinary action to result from the bank's failure.

The Parliamentary Inquiry into Banking Standards has also been considering HBOS's near collapse.