How big could the Libor scandal get?

Does Bob Diamond have reason to feel miffed?

Only enthroned last January as Barclays chief executive, his resignation last week was reportedly forced by the displeasure of the Bank of England governor Sir Mervyn King at his bank's role in rigging Libor.

For those who are still unfamiliar with it, Libor - the "London Interbank Offered Rate" - is an ultra-important benchmark interest rate used in the financial markets.

It is calculated every day by the British Bankers' Association (BBA), and is supposed to reflect the average interest rate at which 16 big international banks based in London can borrow from each other.

So why should Mr Diamond feel miffed?

After all, his bank has agreed to pay a £290m fine after admitting it sought to manipulate Libor for years.

Mr Diamond was in charge of Barclays' investment banking division - the one responsible for the manipulation - at the time.

Well, here are three possible reasons:

Firstly, Barclays has claimed that it was practically forced to under-report its own borrowing cost to the BBA in 2008, because almost ever other bank was also doing so at the time.

Barclays' fear in September 2008 - a time when the global financial markets faced total meltdown - was that its supposedly less dishonest (and therefore higher) reported borrowing cost stuck out like a sore thumb.

To put it another way, if the publicly available Libor data suggested Barclays was having particular trouble borrowing, it could have put the bank (unfairly in Barclays' opinion) on the wrong end of the financial panic, which could even have forced it to be nationalised like RBS.

Secondly, it has emerged that the US and UK financial regulators, including the Bank of England, were well aware since May 2008 that all the banks, not just Barclays, may have been under-reporting their borrowing costs to the BBA's Libor committee.

In other words, the Bank of England had known for years about this problem, but apparently only chose this month to force the removal of Mr Diamond.

Thirdly, the manipulation of Libor by Barclays, and potentially others, since 2007 might even have done us all a favour.

By making it look like they were not in as much financial trouble as they really were, London's banks may have helped to stem the panic in 2008.

Moreover, the lower Libor rate would have resulted in a lower interest rate being charged on the billions of pounds worth of loans to British businesses and homeowners that are linked to Libor.

Yet all these defences miss the real Libor scandal: Barclays did not just admit to having lied about its borrowing cost during the financial crisis.

The bank's traders had apparently been rigging Libor since as early as 2005, long before the crisis began, purely in order to increase their profits (and presumably their bonuses) - although ironically their misbehaviour did not necessarily mean that Barclays as whole earned bigger profits.

Given how arcane the subject matter is, it can be hard for outsiders to appreciate just how shocking this revelation may be for the people, such as Sir Mervyn, whose job it is to regulate the financial markets.

The Libor rate is part of the bread-and-butter of high finance. It is used to calculate the payments on literally hundreds of trillions of pounds worth of financial contracts - several times global GDP, the value of everything produced on the planet in one year.

For regulators to discover that the banks' traders had stooped so low has been a bit like the moment it emerged that News of the World reporters had hacked Milly Dowler's mobile, or that MPs had claimed expenses for the cost of doing up second homes.

In other words, the rigging of Libor may have pushed attitudes at the highest levels to the point of disgust.

What is more, it is hard to see how Barclays could have succeeded in this endeavour without the active collusion of many of the other 15 banks involved in setting Libor.

When the BBA calculates the Libor rate each day, it disregards the four highest and the four lowest submissions it receives from the 16 banks, and then bases the day's Libor on the average of the remaining eight.

It means that if Barclays is acting alone, it has very little ability to influence the Libor rate.

If it submits a rate that is way too high or too low, its submission will simply be disregarded. And even if it does submit a rate within the middle eight, the Libor rate will only rise or fall by one-eighth of the amount by which Barclays misreports its own rate.

All of this raises two big questions:

Firstly, if Barclays is only one of many banks to have misbehaved in this way, is it about to rat on all the other banks involved?

Indeed, could it be that Barclays has actually got off lightly with its fine, because it was the first to come clean? Is the gathering storm about to hit the other banks even harder?

And let's be clear who these "other banks" could be - not just the big UK banks, but also the major US, Canadian, Japanese and continental European lenders. This is a global scandal.

Secondly, if the rigging of Libor has indeed created a sense of disgust among the authorities, have we then reached a tipping point?

Already, the Serious Fraud Office has seemingly reversed course and opened a criminal investigation into Libor.

Could this be the beginning of a much more aggressive exposure of the misbehaviour of bankers during the last decade, going well beyond Libor?