Kate Chamberlain, the inspectorate's chief executive, said that "the likelihood of such an incident occurring might have been significantly reduced" if Deyanov had been dealt with properly.
Deyanov is now serving 20 years in a secure psychiatric unit in Seville for killing her in Los Cristianos, on the south coast of the Canary Island of Tenerife, on May 13, 2011, after being found guilty by a jury in February last year.
He was first admitted to the Glan Clywd unit under the Mental Health Act in June 2010 while he was visiting his aunt, who contacted the police to report her concerns.
Staff found that he had "grandiose ideas that he was the Messiah and has powers from God to save the world", that the Mafia was trying to kill him and that cameras were watching him. But he was released less than three weeks later.
He was admitted again in September that year, and during his stay was overheard saying: "I will have to murder someone to get deported back to Bulgaria." However, he was diagnosed as suffering from consciously simulating his illness, known as "malingering", and once again released.
"The feigning of a serious mental illness is both unusual and rare," said the inspectorate. "A diagnosis of malingering needs to be supported by a substantial evidence base. Our review suggested that this was not the case."
The report also found discharge arrangements were "unsatisfactory".
Professor Matthew Makin, medical director of Betsi Cadwaladr University Health Board which runs the hospital, apologised and said he hoped the victim's family "will be assured that things have changed".
A decision is yet to be made on whether any staff will face disciplinary action but he added: "Work to address most of the recommendations has been under way for some time."
But a statement from Ms Mills-Westley's daughters said the board had "continued to prolong our pain by obstructing our pleas for truth and have become a faceless organisation hiding behind bureaucracy. The way they have treated our family has been appalling".
- Independent