A parliamentary inquiry could be held into Lender Option, Borrower Option (LOBO) loans being mis-sold to local government.

Council leaders - alongside MPs, councillors and civil society organisations - have written to Andrew Tyrie, chair of the Treasury Select Committee, calling for an investigation into how banks, brokers and financial advisers were able to sell the loans to councils.

The letter read: ‘We believe it is important to understand how 250 local authorities came to take out at least £15bn in LOBO loans, containing embedded derivatives. Since the 1989 Hammersmith and Fulham swaps case, the use of derivatives by UK local government has been potentially unlawful.’

Debt Resistance UK first highlighted the controversial practice by revealing councils had £15bn of ‘inherently risky’ LOBO loan borrowing. They also exposed how banks had made up-front trading profits of around £1.5bn through local government LOBOs.

‘Unlike professional investors such as hedge funds, local authorities did not understand the inherent risks with LOBO loans, being reliant upon external treasury management advisers (TMAs) – who received undeclared income streams in the form of commissions from brokers when councils borrowed from banks,’ the letter added.

‘Brokers held themselves out as offering best execution services for local authorities and prior to 2009, failed to disclose relationships with treasury advisers and banks.’

Responding to the letter, Mr Tyrie said: 'Im concerned by this...'

'It is now important to establish whether there is a conflict of interest – and if so, as a consequence, local authorities and therefore council taxpayers have been charged excessively.'

Newham and Tower Hamlets are both facing legal challenges from local residents over their ‘irrational’ use of LOBOs.