The Financial Services Authority (FSA) will come under attack from MPs today for failing to carry out an inquiry after the collapse of Icelandic banks.

The Communities and Local Government Select Committee is furious that the FSA has chosen not to meet its demand for an investigation into losses suffered by local authorities with the banks.

More than 100 councils had nearly £1 billion invested in Icelandic banks at the time of their collapse last October, but so far only £70 million has been returned. Auditors have warned cash-strapped town halls that they may have to wait up to four years to get some money back and may never receive it all.

This year, the committee called on the FSA to investigate why treasury management agencies, which advise councils on investments, allowed dozens of town halls to invest in the Icelandic banks until the moment they crashed. It suggested that there could be a conflict of interest, arguing that treasury agencies advising councils might have had conflicting interests when they or their brokers received commission from the banks.

“Given the sums of public money involved, these remain matters of some concern to us,” Phyllis Starkey, the committee chairman, said. “We are pursuing these issues with vigour with the FSA.”

The FSA told the committee that it did not monitor treasury management advisers because it was not required to advise on deposits. “For this reason, it would not be appropriate for the FSA to carry out the investigations,” it said.

The losses mean that town halls may have to raise council tax next year or cut public services to claw back hundreds of millions of pounds still missing in Icelandic banks. The worst-hit councils will face a lower investment income or pay higher interest rates by borrowing more, finance officers said yesterday. In smaller districts, it could result in higher council tax or service cuts, according to the Chartered Institute for Public Finance and Accountancy.

The Government made an exception this year and said that town halls would not have to balance their books as a result of the missing millions in Icelandic banks. They will not have this concession next year.

Auditors have told councils that they can expect up to 80 per cent of the money back eventually, but no guarantees have been given and each Icelandic bank is operating separately. This means that at least £200 million is unlikely to be returned. The bulk of the cash — £630 million — went to Glitner Bank and Landsbanki, which have not started to process claims.

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