A couple of times recently, I've got on a bus (at least once it was a
108, may have been both times) and the Oyster reader has been broken
(showing red light). The driver has either just waved me past, or
completely ignored me. So I've had a free journey.

But what would happen if an inspector got on? No problem for the
Oyster travelcard users, but presumably for prepay he'd check my card
and find no record of a recent use on this bus route. So would I be
liable for a penalty fare? Should I pay the cash fare to the driver
even if he doesn't ask me to (unfair on me, as this would mean 30p
extra for the bus company)? Or should I have a stash of saver tickets
for this purpose (which defeats the object of Oyster cards - paperless
ticketing)?

I used "Ask Oyster" and received the reply...

In response to your query, in the situation that the Oyster reader is not
working, generally the bus driver will wave you on. In that situation they
should log that their reader is faulty, so if a Revenue Inspector gets on
they will understand the situation. Revenue Inspectors also carry hand held
Oyster readers so if they do scan your Oyster card and see that it is Pre
Pay they will be able to deduct the appropriate fare from your card.

If you are in a situation where the driver does make you pay, unfortunately
you will be required to pay the cash fare in order to travel. If you do
encounter this situation and have to pay the £1, we can refund the thirty
pence to you if you fill in a Refund of Fares form and send us the proof of
payment.

....which doesn't actually cover not having cash available but then I didn't
raise that point.