The fall of Barclays bank chief Bob Diamond is a defining moment in the debate about international banking reform in the wake of the global financial crisis. Diamond has been a vigorous champion of the pre-crisis universal banking model and light regulation. The Libor scandal that resulted in his forced departure and a record fine on the bank has strengthened the case for total separation of retail and investment banking and convinced many doubters.
An international investigation of manipulation of Libor, the London Interbank Offered Rate - a key financial benchmark - has embroiled up to 20 other institutions, including HSBC, Citigroup, UBS and the Royal Bank of Scotland.
As a measure of banks' own costs in borrowing from one another, Libor serves as a basis around the world for what banks, businesses and individuals have to pay to borrow. It therefore influences mortgage and personal loan rates, and rates earned on investments and pensions. Money traders and managements have been colluding in rate-fixing. The filter-down effect on retail rates is not necessarily confined to one or two basis points.
Barclays chairman Marcus Agius and chief operating officer Jerry del Missier also took responsibility by resigning as regulatory probes of rate-fixing went global. American and British regulators have fined the bank US$453 million.
These are shocking revelations. Given the importance of Libor, the process by which it is fixed every day leaves room for more transparency and accountability. It is based on what a panel of banks estimate they would have to pay to borrow, with the highs and lows eliminated to prevent distortion and the rest averaged to set a daily rate. However, Libor was not perverted by a flimsy process but by the investment banking culture of greed that shares in the blame for the financial crisis. Banks' interest-rate submissions were manipulated at traders' requests to cover or enhance their positions. Traders also acted together to get around the averaging safeguard. It has also emerged that Barclays began pitching its Libor submissions on the low side after a supposed misunderstanding of a conversation between Diamond and a senior Bank of England official.
The British Bankers' Association, which is responsible for Libor, should devise a system in which reference to actual lending - rather than guesswork amid conflict of interest - as well as accountability and transparency are safeguards against manipulation.
Meanwhile, the British government has already accepted the principle of separation of retail and investment operations in universal banks through an internal split that preserves financial strength. It may take a total split to resolve a clash of cultures.