A report from the head of the council's financial services said one of the banks is now in the hands of receivers while the other two are expected to have administrators appointed shortly.

Nadine Muschamp said these administrators were expected to report back on how much the council might expect to be re-paid and a timescale for re-payment, but nothing is guaranteed.

Lancaster City Council was one of over 110 local authorities who invested in Icelandic banks which went bust in September. Our council placed £1m in Landsbanki, £3m in Glitnir and £2m in Kaupthing, Singer and Friedlander (KSF).

Ms Muschamp's report states that the council used Icelandic banks successfully on about 20 other occasions since 2006/7, generating investment interest of around £544,000.

And although the KSF bank's credit rating fell below an acceptable level in May 2008, the council was already contractually obliged to transfer £2million.

"Given the relatively minor reduction in ratings, the view at the time was there was no significant risk to the council," said Ms Muschamp.

"At that time there were relatively positive articles in the press ("Ice-landic banks come in from the cold", Financial Times, May 11, 2008) which reported on the banks' first quarter's solid results and indicated some evidence that they were basically sound.

"It was not until September 30 that the bank's ratings plummeted and it failed shortly afterwards."

The council was also due additional investment interest of over £400,000 from the three banks which is at risk.

Ms Muschamp said: "Until some information is known from the administrators regarding prospects for amounts recoverable and the timescales involved, it is not possible to make any reasonable estimates of the financial impact overall."