A shocking failure in service provision left Mr Sharrouf languishing in jail until just before his release in 2009 and exacerbated the mental issues that a judge said drove him to radical Islam.

Mr Sharrouf, a 33-year-old father of five from Punchbowl, is Australia's most wanted terrorist. He shocked the world this week by releasing a photo of his young son holding the severed head of a Syrian soldier.

Psychiatrist Olav Nielssen found in 2005 that Sharrouf, who was imprisoned for his role in the Pendennis terror plot, had suffered depression, acute schizophrenia, paranoia and hallucinations for years.

A court found his illness had ''predicated him towards extremism and radicalisation by others''.

However, he was left ''languishing in prison in an untreated state'' until mid-2008, and his paranoid anxiety would have been exacerbated, said Dr Nielssen, one of the state's leading psychiatrists and a member of the NSW Mental Health Review Tribunal.

Dr Nielssen  said on Thursday that Mr Sharrouf had mental illness dating back to the 1990s.

''There was ample documented evidence of pre-existing mental illness that would have been exacerbated by a lack of treatment when incarcerated,'' he said.

The then-Department of Corrective Services was ''slow to set about fulfilling its duty of care'' and only responded effectively ''with a good deal of prompting'', Justice Anthony Whealy said in 2009.

When Mr Sharrouf was finally treated, doctors noted a remarkable turnaround.

However,  it is understood he stopped taking his medication when he was released and resumed associating with religious fanatics.

He used his brother's passport to slip out of Australia last year and has surfaced in Iraq and Syria, taking part in executions and fighting with the terrorist group Islamic State.

In a statement, Mr Sharrouf claimed he was feigning mental illness to fool the authorities.

Despite recommendations that he be transferred to a secure psychiatric unit, Mr Sharrouf spent most of his time in the secluded ''high-risk management unit'' at Goulburn and Lithgow prisons.

He was so scarred by the high-risk unit that he wanted to sue the state after his release, it is understood.

Prisoner advocate Brett Collins said Mr Sharrouf's case was disturbingly common in NSW prisons and mental health treatment had not improved.

''I can guarantee you that there's another 1000 people in NSW prisons who are saying 'good on you' to Sharrouf,'' he said. ''Rather than be revolted, they would feel that it's a legitimate expression of the anger they feel.''

He said the main form of treatment was medication and inmates often stopped upon release.

''All you're doing is staving off the problem,'' he said. ''You can't impose a change. You need to actually involve the inmate in their own treatment, involve their family or people that they trust. Don't segregate and abandon them.''

Adrian Keller, acting statewide clinical director of forensic mental health for the government's Justice Health and Forensic Mental Health Network, said every inmate was assessed upon entry to custody.

''Over the past decade there have been ongoing improvements to mental health services available to inmates,'' he said, pointing to four new high-level mental health care units since 2006.