Tug of war looms over Dunfermline

Holyrood is preparing to provide the emergency funding but needs the approval of the Treasury as financial market issues are a reserved matter.

Sources say the moves by Scottish ministers may prompt the Treasury to find the money in order to avoid the embarrassment of the SNP claiming a crucial political victory.

The issue has to be resolved within 10 days, which is when the society is due to release its year-end figures. They have already been delayed from Friday and sources say that if funding cannot be found from Scottish or UK Government ministers the society will be forced to seek a merger partner.

To get round the state aid and reserved issues, Holyrood ministers are looking to take on at least part of the Dunfermline's social housing book. The society is the second-biggest provider in Scotland.

A stand-off with the Financial Services Authority has been ongoing for six months after Dunfermline failed to meet tough demands to bolster its capital ratio from 5% to 8% and ensure it has enough money to meet future commitments.

A collapse in commercial property values means Dunfermline will be forced to write down assets, leading to a 26m bottom-line loss for last year, although it may announce a small trading profit.

While the society remains solvent, the vulnerable capital situation is thought to explain why it has not signed off its accounts for the year. It is thought that Dunfermline and one other society failed the FSA's so-called 'stress test'. Dunfermline now risks being forced to find a merger partner, though it is believed no talks have taken place despite a number of informal approaches. A takeover would put 250 jobs at its head office in jeopardy.

The society parted company with chief executive Graeme Dalziel at the turn of the year, bringing in former Nationwide high-flyer Jim Willens. Chairman Jim Faulds is almost certain to stand down at the annual meeting next month and could be replaced by his deputy, Graeme Millar. Other board members Graeme Hardie and Graeme Bissett are strong contenders.

Sources close to the Treasury say the society needs to access the special liquidity scheme which was set up to help rescue the banks. But it needs just 25m to 30m to bolster its balance sheet and guarantee its independence. The reserves currently stand at 100m.

The FSA is thought to have demanded the Dunfermline finds the money from private sources rather than the Treasury. However, raising money on the wholesale markets is expensive and difficult to find, particularly when Dunfermline is known to be exposed to big write downs. Negotiations with third parties, including other building societies, to raise a bond for the sum have proved troublesome at a time when societies are less keen or able to lend to each other.

It is thought the Dunfermline has plenty of cash to see it through the next 12 to 18 months, but needs the liquidity scheme to enable it to lend beyond that timescale. If it failed to raise the money it may need to seek a merger.

As the UK's 12th-largest society, Dunfermline would have to partner with one of the top five if it did need to merge. However, sources in the building society movement say others are facing similar problems. One said up to half the 61 societies could report significant losses for last year.

Scotland on Sunday revealed last year that the society had been forced to take a 9m hit on a bungled IT system.