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Why did councils trust Icelandic banks?

26 March 09 10:24 GMT

By John Andrew
BBC News

Many people will be surprised that some of their council tax ended up in Icelandic bank accounts.

In fact, it is routine for local authorities to invest their income from tax, business rates and other revenue to obtain the best possible return for taxpayers.

Indeed they have a duty to do so. These investments can be for several years or as short-term as a few days or even hours.

Take government grant, for instance, often paid in quarterly tranches. Before it has to be spent on services, wages or bills, some of it is put on deposit to earn interest.

Last year these and other investments yielded £1.8bn in interest - the equivalent of around £80 for every household in England and Wales, though the recession and plummeting interest rates will see that drastically reduced, putting more pressure on council finances.

Angry reaction

Icelandic banks proved a popular choice because of their attractive interest rates, though as a proportion of all council investments they accounted for only about 3%.

That is because councils are told to balance reward against risk and so spread their investments across a wide range of portfolios.

Even so, it is a fact that some 127 local authorities still have a total of £953m at risk in failed Icelandic banks.

Thursday's report by the spending watchdog, the Audit Commission, found most councils had acted properly by heeding warnings about Iceland that began as early as April last year.

But it found seven had acted negligently by investing a total of more than £30m in Icelandic accounts after it was known they were heading for trouble, one of them only four days before Landsbanki went into receivership.

Some of the councils have reacted angrily.

The London borough of Havering says external auditors had given its investment strategy a clean bill of health. The council had the misfortune to have invested £2m in an Icelandic bank on 1 October - only 20 minutes before it was told the bank's credit-rating had been downgraded.

Optimistic prognosis

So what prospect is there of getting all the money back? For some months now, talks have been held between local authority leaders and administrators for the failed banks, both here and in Iceland.

The latest prognosis is optimistic. Both the Local Government Association and the Audit Commission seem confident that a lion's share of the money will be recovered, though in what timescale is anyone's guess.

It took years, for instance, for councils caught up in the 1991 collapse of the Bank of Credit and Commerce International (BCCI) to retrieve their money, but they did get most of it back in the end.

When BCCI went bankrupt it owed more than £6bn to thousands of depositors in 69 countries.

So far there has been no suggestion that any council services or town hall wages are at risk because of money tied up in Iceland. Nor are there any implications, for the moment at least, for council tax bills.

Ministers have made it clear that while they are ready to offer every help and advice to councils affected, there will be no financial bail-outs from the government.

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