The head of the sleaze watchdog stunned Westminster yesterday by pre-empting the outcome of the ten-month police investigation into whether political loans were offered in return for peerages.

Sir Alistair Graham declared that he had no doubt that Labour and the Conservatives never intended to pay back some of the £30 million in secret loans that were used to fund their 2005 election campaigns.

This would be a criminal offence under laws passed in 2000, which allow secret loans only if they are on “commercial” terms, MPs said yesterday.

The issue of commerciality is at the heart of the police investigation in which 90 people, including Tony Blair, have been interviewed and three have been arrested.

Sir Alistair said: “Let’s be in the real world about this. I have no doubt that when those loans were being made that people thought, ‘Well, hopefully we’ll be able to lengthen the length of time over which the loan is repaid or we may be able to translate it into a donation’.”

He later said that parties “breached the spirit” of the law but claimed that he was not making a judgment on the legality of the parties’ conduct.

Norman Lamb, the Liberal Democrat MP for Norfolk North, said: “If some of the loans were never to be repaid, they were not properly commercial. Therefore this would amount to a criminal offence and this is a fairly devastating analysis from a very credible person.”

Sir Alistair’s judgment came at the publication of a critical report into the Electoral Commission, which was labelled weak, incompetent and lacking in courage for its failure to act over secret loans and postal fraud.

The report, by the Committee on Standards in Public Life, which Sir Alistair chairs, argues that the commission should have taken early action over secret loans after being alerted by a Times article on million-pound Conservative loans in April 2005, two weeks before the general election.

In the article, Lord Goodhart, QC, then the Liberal Democrat Shadow Lord Chancellor, was quoted as questioning whether the political parties were circumventing the spirit of the rules on transparency.

Sam Younger, the chairman of the commission, said in the article that he would investigate the issue further, but the commission did not act for 11 months.

“The law does not currently require a loan made to a political party on commercial terms to be declared as a donation,” he said.

Mr Younger later justified his failure to issue a public statement until March last year, saying he feared that “we might well be criticised”.

The committee is not aware of any evidence that the Electoral Commission addressed this issue, or instigated any investigation into the circumstances behind the loans.

Yesterday Sir Alistair criticised the commission’s “passive” approach to regulation, which he said amounted to “regulatory failure”.

He said: “They really should have pushed warning shots across the boundaries of the political parties that they would take a very dim view that if significant loans to political parties were being entered into which were not applying commercial rates of interest.”

He said that the commission should have issued guidance to help parties to decide what constituted a commercial rate of interest.

Sir Alistair stopped short of calling for the commissioners to resign, but called for an overhaul of the body. His committee wants a “compliance unit” to carry out speedy investigations into party finances when evidence of wrongdoing is presented.

The Electoral Commission indicated yesterday that it agreed with many of the conclusions of the report, but sources said that they were unhappy with the “unnecessary” tone taken by Sir Alistair.

One source said: “It’s ridiculous to suggest that a bit more guidance from the Electoral Commission would have prevented the parties from preventing loans and keeping them secret. The parties took their own legal advice and have always said that the loans are commercial so didn’t need to be declared. This is for the law to decide.”

The source added that the commission was unable to act between April 2005 and March last year because it had no evidence of the scale of the secret loans. It had taken action the moment the information had been made public.

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