Labour may have received up to £12m in secret loans

Tony Blair has failed to quell the row over "cash-for-peerages" amid reports that Labour may have received as much as £12m in secret loans before the last election. The Prime Minister said he knew that three millionaires he put forward for peerages had given loans to the party totalling £3.5m.

He also announced a shake-up of the honours system to defuse the row caused by the attack on him by Jack Dromey, the Labour treasurer, for taking the loans without telling him.

But speculation was rife that an internal inquiry ordered by Mr Dromey will uncover several other similar advances. His wife, Harriet Harman, has given up her ministerial responsibility for political finances to avoid suggestions of a conflict of interests.

The issue has also focused attention on the role of Lord Levy, Labour's chief fund-raiser.

Mr Blair has bowed to the Lords Appointments Committee, which blocked the three names and removed Chai Patel, the head of the Priory clinics, who loaned Labour £1.5m, from the peers' list. The two other lenders, Barry Townsley, a stockbroker, and Sir David Garrard, a property developer, have asked for their names to be withdrawn. .

The Prime Minister said: "I did, of course, know ... about the donors... and the fact they had made loans to the Labour Party.

"It cannot be a barrier to a peerage, the fact that you have supported the Labour Party. I believe all of these individuals... would have made a good contribution to debates in the Lords."

Cabinet colleagueswere furious about the disclosures over the loans. Mr Blair briefed his colleagues before announcing a shift of policy on the honours system, which was seen as an attempt to shake off some of the mud that has begun to stick to him over the affair.

The four key reforms announced by Mr Blair were: the appointment of an independent honest broker to hold cross-party talks on more state funding for political parties; a new adviser on conflicts of interest for ministers; bringing forward Lords reform; and cutting the Prime Minister's right to put people forward to the Queen for minor honours such as knighthoods and MBEs. That role will be taken over by Gus O'Donnell, the Cabinet Secretary, but Mr Blair is refusing to give up his powers of patronage to nominate supporters for peerages.

The rules are also certain to be changed to force lenders to disclose loans in future after the Electoral Commission, which acts as a public watchdog on party funding, called for the move. The £15m cap on general election spending could also be tightened.

The row could lead to some of the lenders demanding their money back. Mr Blair defended his decision to nominate the three for peerages, saying they were past Labour donors. However, Sir David donated £70,000 to the Tory Party when William Hague was the leader.

Mr Blair denied any impropriety. However, his admission that he knew that loans had been given weeks before nominating the lenders for Labour seats in the Lords fuelled allegations that he was using peerages as rewards for funding.

He admitted that he had not informed the House of Lords Appointments Commission that the three men he had nominated for working peerages had made the loans before last general election. "The rules that have been in place ... are that loans are treated differently from donations," he said.

Asked where the money from the loans had gone, Mr Blair said: "The money went ... on the general election and its aftermath."

Allies of Mr Dromey said it appeared that Mr Blair had been forced to announce the reforms because of the row. Ian Davidson, a Labour dissident, accused Mr Blair of running a "parallel party" from Downing Street.

Tony Wright, the Labour chair of the Commons Public Administration Committee, said: "Not for the first time in our public life, it takes a scandal and a crisis to produce reform."