Councils deemed negligent over Iceland banks

Local authorities "negligently" deposited almost £33 million in Icelandic banks in the final days before their collapse, the local government spending watchdog warned today.

The Audit Commission found that seven English authorities breached official guidance and their own treasury management protocols in continuing to invest in Iceland after the banks' credit ratings were downgraded below acceptable levels.

One authority failed to open an email warning of the ratings change, another was using out of date information, while a third exceeded its own limit for deposits in a single bank.

In total, £32.8 million was deposited between the downgrading of the banks' rating to "adequate" on September 30 last year and the collapse of the Glitnir and Landsbanki banks on October 7.

The biggest investor, according to the Audit Commission, was the South Yorkshire Pensions Authority which deposited £10 million on October 2, followed by Kent County Council which made two deposits totalling £8.3 million on October 1 and 2.

The others to make deposits during that period were North East Lincolnshire Council (£4.5 million), Redcar and Cleveland Borough Council (£4 million), Restormel Borough Council (£3 million), London Borough of Havering (£2 million), and Bridgnorth District Council (£1 million).

The commission said that the authorities involved had "negligently deposited money after credit ratings for Icelandic banks were downgraded below acceptable levels."

In all, 127 English local authorities had a total of £954 million deposited with Glitnir and Landsbanki when they went into administration. It remains unclear how much - if any - of that money will be recovered.

While overall the figure accounts for just 3.1% of the total funds held on deposit by English authorities, 18 of those involved have more money at risk than they have in their reserves.

The commission found that authorities halved their investments in Icelandic banks during the course of 2008 - from more than £2 billion at the start of the year - in the face of a series of warnings about their creditworthiness.

Nevertheless, from April 2008 - when Fitch rating agency put all Icelandic banks on a "negative watch" rating - £564 million was made in new deposits which were not due to mature until after October.

"Confidence in the creditworthiness of some of the Icelandic banks changed relatively rapidly and, between January and September 2008, a number of credit rating downgrades were announced which should have prompted treasury managers to review the creditworthiness of the Icelandic banks," the commission said.

The commission said that the Icelandic banking collapse had exposed the "variable" standards of treasury management in local authorities.

"Treasury managers could and should have been aware that there were risks associated with making investments and that, in particular, there were risks associated with investing in some institutions," it said.

"Good treasury managers recognised those risks and managed them appropriately. Others either did not appreciate the risks, or underestimated their significance."

The commission acknowledged that it had had to review its own approach after itself investing £10 million in Iceland, but insisted that this did not compromise its ability to analyse what went wrong.

"There is no doubt that the circumstances leading up to the collapse of Icelandic banks were highly exceptional, but the potential loss of nearly a billion pounds is of great concern," said Audit Commission chief executive Steve Bundred.

"We found that most local authorities heeded the warning signs about Icelandic banks. But some did not, and a number were negligent. Our report shows that there are lessons that must be learned by everyone."

Local government minister John Healey said: "The Audit Commission's report is clear that our guidance rightly emphasises an approach to investments based on identifying and managing risk.

"But they do conclude that some authorities may have struggled interpreting credit ratings and assessing the type of investment that suits them best - balancing appropriate risk with higher levels of security and liquidity.

"It is right that the guidance is as clear as possible. That is why I have asked my officials to work with the Audit Commission, CIPFA (Chartered Institute of Public Finance and Accountancy) and the local government associations to assess how it might be clarified in the light of both this report and the forthcoming report from the Communities and Local Government Select Committee."

The Commission found no evidence that potential losses in the Icelandic banks would lead to service cuts or to council tax rises, he pointed out.

The Local Government Association (LGA) said councils currently expected to get back the "lion's share" of their Icelandic investments.

LGA chairman Margaret Eaton said the Audit Commission report showed the way that councils made investments needed to be adjusted rather than replaced.

"It is in everyone's interests that councils continue to invest and ensure that they are doing so prudently."

Shadow local government secretary Caroline Spelman said: "Labour ministers must take personal responsibility for this public policy disaster, given they knew of the risks and created this flawed regulatory system."