The Treasury stepped in yesterday to help the stricken Investors Compensation Scheme by offering to underpin its payouts to savers by up to pounds 17m until a legal challenge mounted by Sun Life is settled.
The rescue came only hours before the ICS halted compensation offers to thousands of victims of fraud or bad advice.
Pressure is mounting among financial watchdogs, however, to set the future funding of the ICS on a firmer footing.
As first reported in the Independent, the Personal Investment Authority, the regulator unable to fund its pounds 15.8m bill to the ICS because of the Sun Life challenge, is set to come out openly in favour of a wider levy.
The scheme now has enough money to last to the end of the year. It will be able to use its pounds 10m overdraft with Royal Bank of Scotland while the judicial review granted to Sun Life, the Bristol insurer, is settled.
The Treasury's rescue plan was announced in reply to a parliamentary question by Matthew Banks, Tory MP for Southport.
Anthony Nelson, minister to the Treasury, said: "Investors can rest assured that this important safety net will continue to work properly. The Treasury's move demonstrates our commitment to investor protection."
Richard Lawson, chairman of the ICS, said: "This is very welcome news. The Treasury guarantee - for which I am most grateful - means business as usual."
Sun Life's legal challenge, to be heard in August, centres on whether it must pay its share of the PIA levy, made on behalf of firms that went bust before even joining the regulator.
The insurer believes this would have rendered it liable to legal challenge from its own policyholders. But its actions to protect itself meant that the entire compensation mechanism was thrown into jeopardy.
The product levy proposals are aimed at overcoming the ICS's long-term funding problem. Sources at the PIA said yesterday a discussion document would appear in the autumn.
A levy would be based on a tiny percentage of a financial product's cost. If a scheme is agreed by PIA members, it could be put in place by the 1996-97 compensation round.
Meanwhile, evidence mounted of dissatisfaction among financial regulators at what they see as excessive controls they face at the hands of the Securities and Investments Board, the City's most senior watchdog, headed by Andrew Large.
PIA sources said they were worried by mounting costs at the SIB, for which they have to pay: "Duplication of costs are picked up by the investor in one way or another. We receive a consultation document on how much we have to pay the SIB each year. But it is hard to avoid the conclusion that this document is a charade and the bill is a fait accompli."