Banks could lend to local councils

Banks and finance houses searching for somewhere new to park their money may soon find a completely new type of offer in the money markets - the chance to lend to local councils.

This has never happened before partly because the rules setting down what town halls are allowed to do with ratepayers' money are very complex, but mainly because it has never been worth the councils' while.

In the past, they borrowed at the Public Works Loan Board, which used to lend at below the commercial rate. But last October, the Chancellor George Osborne put up the interest rate charged by the PWLB by almost one per cent. Since councils in England and Wales borrow around £50 billion a year, the decision added £50 million to their costs, and opened up the possibility that there might be cheaper ways to borrow.

The alternative, now being explored by the Local Government Association, is that the larger councils on their own, or the smaller ones acting collectively, could issue bonds which could enable them to borrow at 0.6 per cent above the base rate, saving millions of pounds a year.

If the scheme can be made to work, it will finally dispel the long shadow of the financial disaster that engulfed a London council nearly 25 years ago. Faced with cuts in government grants and restrictions on the rates they could charge, councils experimented in the late 1980s on the money markets in the hope of balancing the books without cutting services.

Hammersmith and Fulham gambled a large sum on interest rates falling, and faced ruin when they went up. However, the council won an unusual legal victory by getting a court to rule that they had broken the law by putting ratepayers' money at risk, which meant that the banks had to take the loss.

That court ruling would not prevent a council from issuing bonds, which does involve gambling. Wandsworth Council, in south London, which has a long history of charging one of the lowest council taxes in the country, is considering being the first into the field, to take advantage of changes to the council house subsidy system that come into force next April.

Guy Senior, Wandswoth's finance spokesman, said: "The intention is for us to issue a bond and repay it all within ten years. This is likely to save us something in the region of £6.4m to £10m over that period. This extra money will then be available to fund additional investment in our housing stock and improving local housing estates.

"The new rules mean the council will be free to keep all the rent it collects and all the money it generates from vacant house sales and the disposal of land. This will have very significant long term financial benefits for the borough and for local tax payers."

Over the longer term, the LGA is hoping to create a new agency that would give smaller councils that lack Wandsworth's financial clout access to the money markets. A steering committee has been set, headed by Councillor Edward Lord, from the City of London.

Mark Luntley, of the LGA, said: "Setting up a collective agency is not cheap, but the costs are a fraction of the potential savings. And if we can pull this off, it will be one of the biggest developments in how we pay for infrastructure in local government."