* Watchdog accuses banks of selling wrong products to wrong people
* Sector must realise things have to change
By Huw Jones
LONDON, July 2 (Reuters) - Barclays' record fine for rigging Libor interest rates should be a "watershed" moment for the wider financial industry to clean up its act and restore public trust, Britain's markets watchdog said on Monday.
The Libor penalty and last week's news that Britain's top four banks mis-sold interest rate swaps to small businesses compounds the stereotype of a sector that cannot be trusted and left to its own devices, said Tracey McDermott, acting head of enforcement at the Financial Services Authority.
"Instead, it sells products to the wrong people at the wrong time in the wrong way. To change things in the future, to restore that trust and confidence... requires tough action from the regulator but it's not our job alone," McDermott told an FSA conference.
"Perhaps the reaction to the penalty imposed last week on Barclays will be a watershed moment, the point when the industry realises that it also has to rise to the challenge and to recognise that things have to change," she said.
She said Barclays was not an isolated case in the Libor scandal as the bank's chairman Marcus Agius quit on Monday.
The FSA will be scrapped early next year as part of a supervisory shake-up designed to learn lessons from regulatory failings in the run-up to the 2007-09 financial crisis.
Enforcement will handled by the new Financial Conduct Authority (FCA) and its chief executive designate, Martin Wheatley, said the FSA's "credible deterrence" policy of cracking down hard on market abuse would continue.
"We hear critics say we are moving too much towards a nanny state and absolve consumers from their own responsibilities. It's quite clear from our perspective that is not what we are doing," Wheatley said.
The FCA will have powers to act faster and intervene earlier to ban products -- subject to approval from its board -- without an initial detailed probe if consumers are being harmed.
"We will not be deterred from taking on and tackling wrongdoing no matter how complex the case," Wheatley told the audience of financial services firms.
The watchdog screened video clips of how the industry was treating customers poorly, including one woman at the end of her tether trying to get a pet insurance policy to pay up.
In another case, a firm advised a sick woman, keen to ensure her husband would be cared after her death, to put nearly all her assets into a high-risk mutual fund.
McDermott said "wave after wave of mis-selling scandals" meant the role of regulators must be rethought and warned firms which fail to improve despite repeated requests.
"We need to have a low tolerance for firms that constantly bump along the bottom. We will be much more prepared to intervene and limit business," McDermott said.
The conference was billed as the FSA's last enforcement event though Wheatley noted there were many new provisions being added to a draft law now making its way through parliament to put the new regime on a legal footing, meaning it could take more time than thought.