Lord Levy, the Labour fundraiser and one of the Prime Minister's closest allies, has been arrested and questioned over the cash-for-honours scandal.

The peer was held this morning by Scotland Yard detectives investigating claims that wealthy donors were asked to lend rather than donate money to the Labour Party and were then recommended for honours.

He was bailed this evening, after more than six hours in custody. Lawyers for the peer tonight issued a statement saying that Lord Levy had denied any wrongdoing, and accusing the police of using their arrest powers "totally unnecessarily".

"Lord Levy has made it clear that he is ready at all times to co-operate with the police investigation," said the statement.

"He therefore complied with a request to attend today at a police station where the police used their arrest powers, totally unnecessarily, apparently in order to gain access to documents that Lord Levy would quite willingly have provided without this device.

"He has not been charged and does not expect to be, as he has committed no offence. He vigorously denies any wrongdoing."

The arrest follows allegations - first revealed in The Times on Saturday - that a senior Labour Party figure told Sir Gulam Noon he did not need to inform the committee vetting his Lords nomination about a £250,000 loan to the Labour party. The BBC has since identified the Labour figure giving the advice as Lord Levy.

He allegedly offered the advice to the Indian food entrepreneur in a telephone conversation last October, after Sir Gulam had declared the loan in papers to the committee.

Sir Gulam subsequently retrieved the papers from Downing Street and submitted them again without mentioning the loan. His peerage was later blocked when the loan came to light.

The businessman says that he had "done nothing wrong" and maintains that he had declared the loan in his nomination papers.

Lord Levy plays tennis with Tony Blair and is also Mr Blair's special envoy to the Middle East.

He is nicknamed Lord Cashpoint for his central role in raising funds for Labour, a role at the centre of allegations that major Labour financial backers were rewarded with nominations for peerages and other honours - something the party strongly denies.

Police have asked two parliamentary committees to postpone evidence sessions with the peer in order to avoid prejudicing their own inquiries.

Alex Salmond, the leader of the Scottish National Party, which reported its concerns over cash-for-honours allegations to the police, said: "The water is lapping up the beach, it's round the ankles of the Prime Minister.

"This is Tony Blair's personal friend, bagman and fundraiser. I think we can say that Tony Blair's personal pack of cards is starting to tumble down."

David Davis, the Shadow Home Secretary, said that the arrest meant that the Prime Minister himself would almost certainly have to be interviewed by detectives.

"I’m quite sure Scotland Yard will have to question Tony Blair because he is at the top of the honours process," said Mr Davis. "The police are clearly taking this seriously, quite properly in my view. It must be pretty worrying for the top ranks of the Labour Party."

A Labour Party spokesman said: "The Labour Party has and will continue to cooperate fully with this police investigation, and because of the ongoing nature of the investigation we will not be commenting further."

The high profile investigation is being led by Deputy Assistant Commissioner John Yates, one of Scotland Yard’s most senior detectives. The force has said it hopes to make an initial submission to the Crown Prosecution Service on the allegations this autumn.

Scotland Yard said that a man was asked by officers from the Specialist Crime Directorate - which is responsible for the cash-for-honours inquiry - to attend a Central London police station this morning.

A police spokesman said: "Officers from the Specialist Crime Directorate requested a man to attend a London Police Station this morning where he was arrested in connection with alleged offences under the Honours (Prevention of Abuses) Act 1925 and Political Parties, Elections and Referendum Act 2000."

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