Sir Fred's generous pension angered many people
Bank pay policies were reckless and City minister Lord Myners displayed "naivety" over the pension of ex-RBS boss Sir Fred Goodwin, MPs say.
Sir Fred gets £703,000 a year from RBS, which almost collapsed under his watch.
Lord Myners should have given RBS a "clearer, stronger direction" that failure was not to be rewarded, the Treasury Committee report on pay said.
Remuneration policies had led to "a lethal combination of reckless and excessive risk-taking", it added.
The report - the latest in a series on the banking crisis - also blamed regulators for feeble oversight and called for greater transparency about pay.
RBS is now 70% owned by the taxpayer after a £20bn government bail-out. Sir Fred left after the bail-out.
KEY FINDINGS OF THIRD TREASURY COMMITTEE REPORT
Bonus culture in banks needed to be overhauled
Shareholders failed to scrutinise decisions by company board and management
Auditors failed to highlight developing problems in the banking system
The media acted "generally responsibly" in its coverage of the financial crisis
The bank's board decided to treat him as having retired at the request of the bank - in effect boosting his pension as they did not make any reductions for early retirement.
Lord Myners - who said he did not know that the board had taken this approach - should not have allowed the bank's board to handle the pension negotiations on its own, MPs said.
"We suspect that Lord Myners' City background, and naivety as to the public perception of these matters, may have led him to place too much trust in the RBS board."
Lord Myners could have insisted that " Sir Fred should be dismissed", the MPs added. This would meant that Sir Fred would have got a much smaller pension of £416,000 a year from the age of 60.
Earlier this year, Sir Fred and Andy Hornby, the ex-leader of HBOS, gave evidence to the Treasury Committee. They began by apologising for their banks' failings, apologies which had a "polished and practiced air", the report said.
WHO IS LORD MYNERS?
As City minister and one of a select band of City experts drafted in by the PM, he battled to stop the collapse of the banking system last autumn
Carried out an influential review of pension fund regulation in 2000 for Mr Brown, the then chancellor
Former teacher, financial journalist, banker and pension fund manager
"These witnesses also betrayed a degree of self-pity portraying themselves as the unlucky victims of external circumstances," the report said.
"The banks that have failed did so because those leading and managing them failed," the report added.
The Treasury committee, said the crisis had "exposed serious flaws and shortcomings" in remuneration policies.
For example, cash bonuses were paid immediately, regardless of the long-term impact of a deal or transaction.
Non-executive directors of banks had been ineffective in failing to control excess, Committee chairman John McFall added, accusing them of forming "cosy cartels" on remuneration committees.
While governments, politicians, regulators and central bankers had also failed to check the culture of excessive risk taking, bank boards "must also take a large share of the blame" he said.
However, the Treasury Committee report did not call for bonuses to be done away with at Lloyds Banking Group and RBS, the part-nationalised banks. Staff on modest salaries, who should "not be penalised for failures at the top of the organisation", it said.
The British Bankers Association said the report was a helpful contribution to the debate on the future of the UK's financial system but warned that the "pejorative language" used in the report could hurt the reputation of the sector.
"Of course we need to put things right in the UK, but we also need to remember that what we say and do is being watched keenly by contenders for our business," it said.
Business as usual?
Genuine reform is needed, the report said, including the introduction of powers to get back bonuses where they had been given unfairly.
"We have a suspicion that many bankers remain unconvinced by the need for change and believe that, once 'the storm dies down', it will be a case of 'business as usual'," the report said.
It called on the Financial Services Authority (FSA) to get tougher with banks about their pay policies. "We are concerned that the FSA seems not be taking tackling this issue seriously enough," Mr McFall said.
However the watchdog refuted the charges, and said that payment structures had been one of its main focuses for the past year. It added that it would "take action if we believe firms have remuneration policies that may encourage unacceptable levels of risk".