McDonnell urged the government to act after analysis by campaigners revealed the extent to which councils are losing out by paying high interest rates attached to LOBOs.
Research for Action, an investigations cooperative, found the 10 councils with the most LOBO borrowing by value could have saved £4bn over 40 years by refinancing via the Public Works Loan Board.
Kent County Council, and Northamptonshire County Council both announced that they were refinancing LOBO loans earlier this month.
For the 240 councils that have taken out LOBO loans, savings could reach £16bn over the lifetime of the loans if the debt was to be refinanced through the PWLB, Research for Action said.
McDonnell said: “The government has a role to play now in ensuring there is a full, independent and open investigation into the use of these financial instruments and action taken to restore any historic loss to the public purse.”
A report, published in October, by Research for Action found some councils were paying more than 11% on interest rates for some LOBO loans, while they could be paying just 1.7% on loans taken out from the PWLB.
Councils spend a significant amount of their income on interest payments – sometimes as much as nearly 70% of what they receive in council tax income, the Research for Action report said.
Newham Council, which holds multiple LOBO loans, spent £75m on interest payments on its debt in 2017-18. That is the equivalent of 110% of its council tax income going towards interest payments, the research found.
The report said: “By comparing the fair value of the loans when they were taken out, financial analyst Nick Dunbar estimated that Newham Council could have saved £10m every year by using PWLB loans rather than LOBO loans”.
LOBO loans can often offer interest rates below that of central government’s PWLB, but allow lenders to change rates at set times in the future.
Refusing to pay updated interest rates requires councils to pay back the loan in full.
A Newham Council spokesperson said: “This administration has serious concerns regarding the mis-selling of LOBO loans and manipulation of the LIBOR rate by Barclays and potentially other banks”.
In July, PF reported that 14 local authorities were planning legal action against Barclays Bank over LOBO loans due to accusations of LIBOR rate rigging.
In August, Lancashire County Council’s accounts were delayed after concerns were raised as to how to account for its LOBO loans.
