Foreign Secretary Jack Straw has insisted that peerages are not for sale under the Labour Government.
Dr Chai Patel has donated and loaned money to Labour
He spoke out after Chai Patel, the head of the Priory rehab clinics, revealed he had loaned Labour £1.5m weeks before being nominated for a peerage.
The Lords Appointment Commission, which vets nominations for peerages, is said to be against Dr Patel's candidacy.
Mr Straw backs Electoral Commission calls for a change in the law to force political parties to declare loans.
However, he said that being a donor to a "good cause" should not be a reason for disqualifying an individual from an honour.
He told BBC Radio 4's Today programme that Labour had "made government much more transparent" since coming to power in 1997.
"You can't buy a peerage. Donating large sums of money to a good cause cannot be a reason for giving somebody a peerage, nor can it be a reason for disqualifying them."
Jack Straw said he would back greater transparency
The Electoral Commission is reportedly set to demand a change in the law to force political parties to declare multi-million pound loans.
Mr Straw said he had set up the commission when he was home secretary and would support it in securing greater transparency.
'Spirit of the law'
The Electoral Commission is reviewing the issue of loans and expects to say more at the end of this month.
Current laws mean loans given on commercial terms do not have to be declared as a donation, although they have to be shown parties' accounts.
The commission said it would be "against the spirit of the law" if a party tried to avoid the reporting rules by accepting a loan which it later expected to be converted to a donation.
The Committee on Standards in Public Life is also likely to examine the issue as part of its inquiry into the work of the Electoral Commission.
Lord Goodhart, who was on the committee when it drew up the original donation rules, said parties should now have to declare all loans.
People giving loans had more power than those giving outright gifts as they could ask for their money back if they did not like what the party was doing, the Lib Dem peer told BBC Newsnight.
Earlier, the prime minister's official spokesman said a change in the donations process would require all party consensus.
Dr Patel said he made his £1.5m to loan to Labour last summer following a request, but said he never expected anything in return.
The House of Lords Appointments Commission said it would expect to be told about any links that could be seen to influence a recommendation, but refused to comment on individual cases.
LORDS' APPOINTMENT COMMISSION
Set up by the Queen to oversee appointment of peers on merit
Asks the public to nominate themselves or others and then assesses the nominee
It has seven members, three of which represent the major political parties
It has appointed 29 peers since 2001
Source: House of Lords Appointment Commission
The BBC understands that the loan is still outstanding and was made at commercial rates.
Dr Patel, who has also given £100,000 to Labour, said he has been angered by what he sees as the leaking of his candidacy by the commission and has called for transparency.
The Labour Party donor was cleared of misconduct charges by the General Medical Council last year.
Recent reports stated that the appointments commission told Mr Blair to withdraw his nomination.
They prompted Dr Patel to write to the commission, asking for reasons for its reported objection to his appointment and saying his reputation was being traduced.
Reports also claim the commission is unhappy about several other nominees.
A Labour Party spokesman said: "There is nothing wrong with donating or lending money to a political party as long as the rules are strictly adhered to.
"The issue here, regarding the loans that they have made, is whether the strict rules set by the Electoral Commission regarding the declaration of loans that have been made at a commercial rate, have been fully observed. They have."