Banks have revealed billions of pounds in potential losses as a result of alleged fraud by Wall Street investment manager Bernard Madoff.

The Royal Bank of Scotland - 58 per cent owned by the taxpayer - said £400 million was at risk in the hedge funds invested with 70-year-old Madoff, who was arrested last week after police said he admitted a £33 billion scheme to defraud investors.

Spanish bank Santander, which owns Abbey and the savings business of Bradford & Bingley, said its potential exposure was more than £2 billion, while HSBC said it believed it had a potential exposure of around £668 million.

"In the interests of clarity, HSBC confirms that it has provided financing to a small number of institutional clients who invested in funds with Madoff," the company said.

HSBC said its exposure to the alleged fraud stemmed from these transactions.

According to court documents, Madoff - a former chairman of New York's Nasdaq stock exchange - told his employees that his operations were "all just one big lie" and "basically, a giant Ponzi scheme".

A Ponzi scheme is a fraudulent investment vehicle which pays very high returns to existing investors paid for by money put into the scheme by newcomers.

Madoff's arrest will raise questions about the effectiveness of regulatory authorities, which failed to notice the scam.

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