What happened here, by Scott's own account, is that he was remembering the 'medieval' movies of his youth (such as The Black Knight starring Alan Ladd - you've only got to check out the synopsis of that to see how much Scott was channelling that) with their simple moral values, and wanted to make a moral fairytale about knighthood and chivalry for today's youth. Then he ran into Bill Monahan who wanted to make a realistic epic about the Leper King of Jerusalem and the Battle of Hattin, harking back to his memories of reading of Runciman's history in his youth, and they thought they could bring these two objectives together into a single story. But it just doesn't work.
Is that what Scott intended?
I wouldn't say that he was consciously trying to make a fairy tale, necessarily; but at some level he must have wanted to.
Another example, is where Bailian, who had about fifteen minutes of fighting instruction from Liam Neeson, defeats three knights with a couple of handy rocks.