Holyrood and Westminster battle looming over financial relief available to bail out councils who have lost money
By Tom Gordon Scottish Political Editor

RELATIONS between the Scottish and UK governments are set to hit a new low this week, as the two sides fight over how to help Scottish councils with millions frozen in failed Icelandic banks.

At a crunch meeting on Wednesday, Westminster will insist any loss will ultimately fall to the Scottish government to sort out, as local government is devolved. However John Swinney, the finance secretary, will insist that financial regulation of banking is reserved to Westminster, and any bail-out of councils must see Scottish and English authorities treated equally.

On Tuesday, Alex Salmond will convene a special economic cabinet, which will renew efforts to extract disputed monies from Westminster in order to help Scotland through the credit crunch. Ministers have identified £963m of public spending which could be brought forward and used to cushion the impact of the financial crisis on the Scottish economy.

However most is the subject of long-running disputes with the Treasury over council tax benefit, prison spending, and regeneration funds arising from the 2012 Olympics.

The fossil fuel levy surplus, in excess of £120m, the Scottish government's £42m underspend currently held at Westminster, and the council tax benefit mechanism, which has cost Scotland an estimated £100m a year since 2004/05, are among the measures identified.

In addition, the Barnett formula impact of London Olympics regeneration spending, £120m of prisons spending from the Carter review and £40m in police and firefighter pension commutation costs all combine to make a total of £963m.

Swinney wrote to Alistair Darling to make his case on Thursday, as it emerged eight Scottish councils had more than £45 million at risk in Icelandic institutions.

The chancellor, in the United States this weekend for a meeting of the G7 on how to address the panic in the stock markets worldwide, has yet to reply.

However Jim Murphy, the new Scottish Secretary, will make plain on Wednesday that the buck stops with the devolved government. Murphy will meet Swinney and Pat Watters, president of the council umbrella body Cosla, at the Scotland Office in Edinburgh.

A Scotland Office spokesman said that the UK government would make every effort on behalf of UK depositors to recover funds from Iceland, and as part of that process Scottish and English councils would be treated equally.

"The starting point is to make sure that the money comes back, and there's no default," the spokesman said. "But in the worst case option, everything that could be done would be done by the devolved adminstration, by the Scottish government.

"The tripartite meeting will go through all the worries that Cosla have, and Jim will say, well, that's devolved, and Swinney and Cosla can take it away.

"The meeting should establish what the Treasury is doing, what the UK government is doing, and what is the responsibility of the Scottish government.

"It's not a question of passing the buck - this has been devolved since 1999."

He said that in the event of councils failing to recover all their money, the Scottish government could help them with their cash flow by re-ordering their budgets and granting permission to use capital reserves for day-to-day spending.

But a senior government source said: "There is not a scintilla of doubt that it is a reserved issue. It's up to the Treasury to decide what to do in these exceptional circumstances. The idea of them extending help to English councils but not to Scotland is unsustainable. If they did that, I would advise them the prime minister and chancellor not to stand at the next election."

The part of Scotland facing the biggest potential loss as a result of the Icelandic collapse is Ayrshire, where all three councils have money frozen in accounts.

North Ayrshire's exposure is £15m, South Ayrshire's £5m, and East Ayrshire's between £3m and £5m. Scottish Borders has £10m invested, South Lanarkshire £7.5m, Moray £2m.

East Renfrewshire and Perth & Kinross each stand to lose £1m if their money cannot be recovered. Around 100 English and Welsh authorities have £750m at risk as a result of the failure of Icelandic banks, including Landsbanki, Heritable Bank and Glitnir