Royal Bank of Scotland is aiming to wind down the remainder of about £1bn in controversial bank loans held by local authorities across the country, after criticisms that high payments have diverted cash from council services.

Campaigners have welcomed the move, which followed similar efforts made by Barclays in 2016 and comes as both lenders face a string of lawsuits.

The loans have been criticised by activists and the shadow chancellor, John McDonnell, who said councils have been on the hook for expensive interest payments that could have been diverted to local services already squeezed by spending cuts. Campaigners against the loans estimate that the cancellation of so-called lender option borrower option loans, or lobo loans, could ultimately save taxpayers £16bn over the next 40 years.

The Guardian understands that RBS is working to wind down the loan portfolio by the end of the year. The main way it is doing this is through loan redemptions: allowing clients including local authorities to pay back the loans earlier than their original contracts allowed, with some offered a discount on their repayment as an additional incentive.

RBS – which is still 62% owned by the taxpayer since its 2008 bailout – has significantly reduced the loans portfolio over the past two years and is expected to fully exit its position on the lobos by the end of 2019.

Birmingham, Kent, Northamptonshire, Sheffield and Newcastle are among the councils to have have taken advantage of the early exit offer.

Lobos were popular among councils in the early 2000s. One of the main attractions were their teaser interest rates that kept costs low in the short-term but proved expensive as austerity and spending cuts took hold. The loans gave banks the power to raise interest rates at certain points over their lifetime, accounting for the “lender option” of the loan agreement. Although borrowers had the option of rejecting those terms, it would trigger a clause forcing them to immediately repay the loan in full.

An RBS spokeswoman said: “Whilst we can’t discuss individual cases, a number of our local authority customers hold legacy, long-dated, lobos loans. We work on a case-by-case basis with all our customers and, as ever, arrangements are confidential. We value all our customers and are open to discussing restructuring or refinancing of such loans where beneficial for the customer.”

Fellow high street bank Barclays converted its lobos to fixed-term loans two years ago, though interest payments were not necessarily affected and breakage costs were only slightly reduced.

But efforts to phase out the loans hasn’t saved either bank from legal action. East London authority Newham is suing both RBS and Barclays over the terms of the loans, having borrowed about £578m in lobos between 2003 and 2010, according to data compiled by the campaign group Debt Resistance UK.

A similar lawsuit was launched against Barclays by seven local councils including Greater Manchester and Leeds over the terms of nearly £573m in lobo loans taken out between them. Their high court claim centres on how interest rates on those loans were influenced by the London interbank offered rate (Libor). Barclays is among the lenders that have been fined for Libor rigging since the banking crisis.

A Barclays spokesman said: “Barclays has filed a defence and will vigorously defend these claims.”

Joel Benjamin, a campaigner for anti-lobo lobbying group Research for Action, said: “Its great to see RBS finally moving to unwind its lobo loan portfolio, two years after Barclays decided to do the same.”

But he said he was surprised that RBS is “suddenly offering councils steep discounts to exit lobos in a fire-sale”, given that RBS had previously said there was no issue with the complex loans.

“Could it be that a tone-deaf RBS has finally worked out lobo lending to bankrupt councils like Northamptonshire is not a good look?”

He said breakage fees for some of the loans have been reduced from more than 200% of the loan costs to about 70% to 80%, “resulting in multimillion pound savings for councils and taxpayers, and a corresponding loss for taxpayer owned RBS”.