Rules which allow town halls to invest hundreds of millions of pounds of taxpayers’ money in foreign banks are to be questioned by an influential backbench committee.

The Communities and Local Government Select Committee announced yesterday that it would examine whether new regulations and guidance were needed to cover council handling of £11 billion of reserves.

The announcement came as 123 councils were still battling to retrieve more than £900 milllion in collapsed Icelandic Banks.

Investment guidance from the Communities Department dates from 2004 when John Prescott was in charge. The guidelines issued then allow councils to invest in any foreign banks provided they are regulated by the British market.

The guidance also changed existing rules which prohibited councils for investing their money in fixed term accounts of more than 364 days a year. Part of the problem in the current Icelandic bank crisis is that much of the missing money has been deposited for two or even three years. Councils would have been reluctant to withdraw the cash over the last few months as they would have incurred penalties and lost interest.

Town halls are also asked to set a level of risk and then achieve the maximum value for money at that level, a task which is carried out by town hall treasury departments.

Dr Phyllis Starkey, committee chairman said all aspects of the guidance would be reviewed. But she argued that if investment in foreign banks was prohibited taxpayers’ money would earn a lower interest return. “ Keeping risk low while ensuring a good return is a difficult balancing act. If councils merely invest in the safest British banks, the tax payer could lose out.”

Dr Starkey stressed that it was not only town hall reserves which were invested. “All the billions collected by councils in housing benefit, council tax and business rates are invested every night in most authorities,” she said.

The committee will also consider whether local councils should invest instead in low risk Government funds despite the lower rates of return. In addition it will consider whether any other bodies should have a role in advising local councils.

A spokesperson for Communities and Local Government said the 2004 guidance was part of the new prudential finance system for local government. “The 2004 guidance is still applicable and we are satisfied that it accurately reflects the advice we wish to give to local authorities. Of course, as with any Government guidance, we keep it under regular review,” he said.

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