"I have been at the FSA/FCA for 15 years and I remain extremely committed to, and passionate about, the important work we do. It has been, and remains, a privilege to lead this organisation," McDermott said in a statement today. "However, going through the recruitment process has made me reflect on what I want to do with the rest of my career.
"As a result I have decided that this is not the right job for me at this stage of my career. This was a decision taken after many months of careful thought and was not one that I took lightly."
The FCA said McDermott will continue as its acting chief executive until the Treasury appoints a permanent replacement.
McDermott has been hotly-tipped to take on the role after chancellor George Osborne failed to re-appoint Martin Wheatley to the regulator's top job last summer.
But Osborne said this morning that McDermott had not been shortlisted because she "doesn't want the job full-time".
Speaking on Radio 4's Today programme, Osborne said McDermott had been a "very effective interim leader", but that the FCA "needs new leadership to take it into its more mature phase".
Osborne said at the time that the government was looking for "different leadership to take the FCA to the next stage of its development".
"Martin’s replacement will – like him – need to be passionate about protecting consumers, promoting competition and completing the job of cleaning up the City, so it is the best-regulated market in the world," he added.
Meanwhile the Treasury select committee said this morning that it has called for McDermott and FCA chairman John Griffith-Jones to appear before the committee to explain why the regulator dropped a review into banking culture last month.
"The FCA's decision to drop its review of bank culture does seem curious," said Andrew Tyrie, the committee's chairman.
“It is not the dropping of the review that is crucial. What matters is the full implementation of the reforms recommended by the Vickers and Banking Commissions and set out to improve conduct in banks. So this session will be a part of the committee’s assessment of the FCA’'s efforts to fulfil the enhanced statutory responsibilities given to it by Parliament over the last few years," Tyrie added.