Tories: Bank crash may hit services

Shadow Local Government Secretary Caroline Spelman warned taxes would have to rise or local services cut amid suggestions councils could only recoup 80% of their investments.

Iceland's financial system seized up in October last year, trapping around £1 billion of UK local authority funds.

According to the BBC, the administrators for one of the banks which collapsed, Heritable Bank, have now indicated creditors will receive around four-fifths of their funds back - equating to a total repayment of about £300 million.

The leader of Kent County Council - which had around £50 million invested with some of the country's banks including £18 million with Heritable - said the payout could be even more if market conditions improved.

"They're hoping to make their first payment towards the end of July and August, 70 to 80 pence in the pound they're predicting," said Paul Carter. "If markets improve, we may get more than that, closer to 90%."

But Mrs Spelman insisted councils were set to lose £186 million, and that would rise to £200 million including loss of interest on the returned capital.

She said: "Whatever gloss is put on the news, it is unacceptable that local taxpayers will have lost £200 million. This will ultimately feed through to higher council tax or less investment in frontline services.

"It is a scandal that the Financial Services Authority and the Treasury knew that Icelandic banks were risky, but sat on their hands and kept quiet. Labour Ministers must take personal responsibility for this public policy mistake, given they created a flawed regulatory system and said nothing."

Last month the Audit Commission said a number of councils "negligently" deposited almost £33 million in Icelandic banks in the final days before their collapse.