The resignation of Bob Diamond, the abrasive, brash American head of Barclays, one of Britain's biggest banks, has created fresh turmoil in the banking industry and threatens to expose a massive global scandal that will further undermine the Western capitalist system.
Mr Diamond resigned – reluctantly and under pressure – after it was revealed that for several years Barclays had consistently engaged in fraud in the setting of vital inter-bank lending rates. The repercussions go far beyond Britain. For Barclays, itself a global player, was not the only bank that manipulated the so-called Libor – the London inter-bank offered rate, which is the benchmark that determines interest rates and the cost of borrowing money around the world. So too did other big names in international finance, including possibly Citigroup, JP Morgan Chase, UBS, Deutsche Bank and HSBC.
The Libor rate is used to set an estimated $800 trillion of financial instruments. If these banks were also engaged in fixing the rate to bolster their own profits or protect their reputations, this could turn out to be one of the greatest financial frauds in history, affecting investors and borrowers around the world.
Barclays was the first bank to co-operate with the authorities and has already been fined $450 million by American and British regulators. Other scandals may come to light when other banks are investigated. The British Government now faces calls from outraged politicians and businessmen for a full public inquiry. And US and Canadian investigators are already scrutinising documents to see how far the fraud spread, and whether other banks have also been engaged in a cartel.
So how does the Libor rate work, and what has Barclays done wrong? In some ways, this was a disaster bound to happen. Libor is not an official or independent yardstick. It stems from the days when banking was a gentlemanly pursuit, on a far smaller scale, and most of the big bankers in London knew each other. They would meet daily to say what they thought they would have to pay to borrow money from each other. The top and bottom estimates were discarded, and the Libor rate was the average of those left. The system depended on trust and honesty. But at a time when banking is becoming more competitive and when the economic crisis of 2008-09 put huge strains on banks' resources, the temptation grew to give out misleading figures – either to allow a bank to borrow at cheaper rates or to give the impression that it had more cash of its own and was therefore in better financial health than anyone worried about a bank's liquidity realised. For several years, it now appears, Barclays and several other banks have been trying to influence the final Libor fixing in order to increase profits or reduce losses on their derivatives exposures.
The sums involved are enormous. And it seems clear that although the bank has tried to blame "rogue traders", Diamond and others at the top knew very well what was going on. In America, investigators have identified price-rigging going back to 2005. But Barclays and other banks can also argue that the regulatory authorities also did little to insist the Libor was a completely honest and transparent benchmark.
The details are too obscure for most people in Britain, including politicians, to understand. But what is clear is that the reputation of bankers, already deeply unpopular in most of Europe, has been further damaged. Not only are they seen to have been greedy and incompetent; it now appears that they were also dishonest. Terrible damage has been done to the once sober image of banking: the traders who were dishonestly trying to manipulate the rate joked with each other. "Coffee coming your way," said one in an email. "Dude, I owe you big time! I'm opening a bottle of Bollinger," wrote another.
And this latest crisis comes when the banking system is in deep crisis in several European countries. Ireland, one of the first members of the euro-zone to need a rescue package for its economy, was brought to ruin by the collapse of its very large banks, which had recklessly lent too much money for property speculation. And Spain, which has just borrowed record sums from its fellow European nations, is in deep economic trouble because of the collapse of the housing market, leaving the banks with huge bad debts.
The decisions at the start of the economic downturn by most Western countries to save their failing banks by lending them enormous amounts of money was deeply unpopular. Many voters said it removed moral responsibility for the crisis from the bankers themselves who had made so many bad decisions. But Western politicians argued that a collapse of the banking system would have even worse effects on national economies, and that taxpayers therefore had to come to the rescue.
More than £3.7 billion has been wiped off Barclays' market value since the Libor revelations. The bank, the second largest in Britain, is now under siege by angry customers and politicians, and already many big companies, especially in America, have begun multi-million dollar lawsuits because of the higher cost of borrowing money. Altogether some 20 banks, including most of the big names in Europe, are being sued. One market analyst compared this to the wave of lawsuits against tobacco companies in 1998, which eventually cost the tobacco industry well over $200 billion.
What will happen now? For Barclays, these are desperate moments in which to save the bank. First it has to find a new chief executive and chairman, who also resigned. Then there are plans to divide the bank into two, separating the traditional banking for clients and businesses from the investment arm, which takes more risks and has a more cowboy culture. Such a separation was urged on many Western banks after the collapse of Lehman Brothers in 2008, and may soon be officially ordered by the British Government.
There will also be tougher regulation around the world. Without trust, no banking system is effective. Investigations will probably lead to a number of bankers in Britain and elsewhere being sent to jail. Future reforms will insist that the Libor, and the European equivalent known as Euribor, are set not on estimates but on the actual costs of borrowing. This may prove difficult to work out, especially if markets are sluggish and there is not enough trade to be able to set a benchmark. Whatever emerges will have to be supervised by an independent regulator.
Meanwhile, banks around the world are anxiously examining their records. And old-fashioned communists, who always said the capitalist system was based on exploitation, will insist that their prophecies of collapse were right. In truth, the world's economic system is facing yet another challenge. And bankers can expect to remain at the bottom of the public's affection and respect for years to come.
