The “lynch mob” mentality that cost Fred Goodwin his knighthood and fellow banker Stephen Hester his bonus will damage British business, Lord Jones of Birmingham has warned.

Digby Jones, the former CBI Director General, said foreign entrepreneurs will be discouraged from doing business in this country because of the way high-profile bankers had been treated.

Giving evidence to a Commons inquiry, Lord Jones, who received a knighthood before becoming a peer, also called for reforms to the honours system to remove references to the British Empire.

He said the use of titles such as Commander of the British Empire caused embarrassment overseas, where the empire was not remembered fondly.

Speaking to the Commons Public Administration Committee, Lord Jones criticised the way former Royal Bank of Scotland Chief Executive Fred Goodwin was stripped of his knighthood following a wave of public anger over his role in the banking crisis.

It was not clear what rules Mr Goodwin had broken, if any, and there did not appear to be any process in place giving Mr Goodwin a chance to defend himself, Lord Jones said.

He said: “The problem of course is this was no way to go about meting out any form of discipline or sanction or punishment. It had the whiff of the village green lynch mob about it.”

He added: “The biggest pressure of all was the headlines in the newspapers and a government that said ‘I’m going to listen to that to satisfy the mob’ . . . it was nothing less than punishment, and punishment in our nation should be meted out after due process and a proper trial.”

The public outcry that caused Royal Bank of Scotland Chief Executive Stephen Hester to turn down his £1 million bonus, at around the same time that Mr Goodwin lost his knighthood, was also bad for business, said Lord Jones.

He compared the way the two men were treated to reign of terror which followed the French Revolution and the storming of the Bastille on July 14 1789.

“Suddenly you have in this, and in the disgraceful behaviour the lynch mob showed to Stephen Hester’s bonus at the same time, the rule book went out of the window, transparency went out of the window, predictability went out of the window, and they responded to the 14 of July at the Bastille and the guillotine.”

Foreign entrepreneurs had always been attracted to Britain because it was a country where the rule of law held sway, he said – but the way bankers had been treated might change that perception.

He said: “If I was that young man in Bangalore I might think maybe there are better countries to plough my furrow in than Britain. That actually will be the greatest casualty of this.”

Lord Jones said he believed Britain should drop references to the world “empire” in the honours system, following his experiences promoting British industry worldwide.

As well as his role with the CBI, Lord Jones served as a trade minister in Gordon Brown’s government.

He said: “One of the ways we’re going win in he 21st century is we are going to win on merit. And we’re going to shelve and dismiss the arrogance that comes from 200 years of Empire, and we’re going to show the world we are damn good at what we do.”

When he had travelled with trade delegations he had often been asked why a colleague had letters such as “CBE” after their name, and was forced to explain that it referred to the British Empire, he said.

But for some people overseas, the phrase conjured up images of their own nation fighting for independence against the British, Lord Jones warned.

He told the inquiry that he became a peer specifically so he could do a job in Mr Brown’s government, which he believed would benefit British industry, and he admitted that he did not know whether he should remain in the House of Lords now that the job was over.

“When I became a peer I saw that actually as a job of work. I saw that as an obligation and responsibilty to fulfil a job every day. What I find difficult to answer is on that basis, does that mean when you stop doing that job that you stop becoming a peer?

“Don’t know. What I do know is I participate actively in the House of Lords as a crossbench peer and I take part in debates and I’m there quite often.”

Also giving evidence to the inquiry was Labour MP Alistair Darling, the former Chancellor, who revealed he had offered Mr Goodwin advice designed to save his knighthood and his career.

Mr Darling told the inquiry: “Fred’s mistake, and I told him this would happen, was holding on to his pension. If he hadn’t done that he would have been able to dip below the horizon and he’d have reappeared somewhere. As it is, I think the man is virtually unemployable.”

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