The past 12 months have been among the most difficult in memory for local government. Since the storm clouds of recession gathered last summer, bad news has continued to come thick and fast. In the autumn the collapse of Icelandic banks put £954 million of local authority investments in jeopardy. In the winter councils bore the brunt of anger over the death of Baby P, later revealed to be called Peter. There were also transport problems triggered by the coldest weather for years.

The row over MPs’ expenses rumbled on over the spring, causing widespread political disillusionment that culminated in the low turnout at local elections. Yet despite all this, and the loss of 6,700 council jobs in the past seven months, most local authorities have emerged in surprisingly good shape. Swaths of public services have not been destroyed and communities have not been decimated, as many people had predicted.

Better still, it now appears that local authorities will retrieve most of their funds from Icelandic banks. John Harrison, executive director of strategic resources at Peterborough City Council and the local government representative on the creditors’ committee for Kaupthing Singer & Friedlander (KSF), says a minimum of 50p in the pound has already been secured for creditors and a much higher figure is likely — up to 90 per cent of the funds being returned — although the process could take several years.

Peterborough City Council, which had £2 million invested in KSF, has dipped into its £6 million reserves to minimise the impact on services. Harrison says the council has responded to the financial uncertainty by entering a period of retrenchment in which it only invests in safe havens, such as wholly UK-owned banks. But if the recession is forcing councils to be cautious with their investment strategies, it is stimulating more radical approaches to services.

In Essex, which has about 50,000 small businesses, the county council has established a £50 million municipal banking scheme in collaboration with the banking group Santander. The council scheme provides loans and overdrafts of up to £100,000 for businesses employing fewer than 250 people and on turnovers of up to £25 million. Lord Hanningfield, the leader of Essex County Council, says the scheme creates a system of banking responsive to local needs and represents “one of the most fundamental changes in how either our financial or governance systems operates”.

The credit squeeze and the threat of longer dole queues is prompting the council to innovate now to prevent the fallout from higher unemployment later, he explains. Lord Hanningfield describes the past year as the most difficult in his three decades of local government and cautions that although councils have emerged relatively unscathed the worst is yet to come. The Treasury’s next Comprehensive Spending Review, which will set council budgets for the three years from 2011-12, looms large. “We are fearful there will be cuts,” he says. “We are planning to be more efficient but there is a level to how far you can go with that.”

Knowsley Metropolitan Borough Council is also stimulating business by setting up an apprentice scheme that placed 100 young people in full-time work with businesses last year and aims to do the same this year. Apprentices receive work placements offering training to NVQ level 3 while earning £4.83 an hour. The council has offered 18 apprenticeships across its own departments, including housing benefits, youth service and horticulture.

Gareth Davies, managing director for local government at the Audit Commission, the spending watchdog, says links between the public and private sectors have been strengthened. “The crisis has brought out some creativity and willingness to work together in new ways. There is a sense that this is when local government comes into its own.”

David Fry, leader of PA Consulting Group’s work in local government, says that there has been “less salami slicing of budgets” and more thought given to new ways of operating. “The only way to respond to this situation is to be radical. You have to reinvent yourself,” he says.

Fry adds that councils have managed risk well and that cuts have not yet had a big impact on the quality of services. “The past ten years have seen a huge improvement in council performance. Performance assessments from the Audit Commission have made a big difference to how councils are run.”

The spectre of the Spending Review means that the danger is not over. Councils will have to think harder than ever about managing on less.

Times Recommends

• Minister in talks with Saudis to protect creditors
• Premier Inn hits back in £29-a-room row
• Bankers hit back at 'populist' bonus supertax