So while the heads of Barclays’ top executive bankers rolled onto the streets of Canary Wharf and central bankers look to preserve their own, politicians, regulators and the press, like gannets, are in feeding frenzy mode.

Libor is used as a benchmark that establishes interest rates on trillions of dollars worth of consumer and business loans. Knowing where it is headed is a clear advantage to derivative traders. Internal messages at Barclays revealed that for each basis point Libor was moved, those involved could net “about a couple of million dollars”.

Let’s be clear, manipulation of the London Interbank Offering Rate, a fundamental gauge for credit worthiness banks have for each other, is a shameful act.

But before this becomes just a simple tale of self-interest and greed, there are grounds to believe banks were deliberately lowering their numbers in order not to panic the credit markets any more than they were already. The problem is that by rigging the game traders were also reaping very lucrative financial rewards at the same time. This is a dangerous conflict of interest and exposes Libor's flaws.

In a UK parliamentary hearing on July 4, Robert Diamond, the former CEO of Barclays threw a grenade over the parapet by suggesting the Bank of England was repeatedly told about the dodgy numbers being posted by the banks. On Monday (July 10), the BoE’s deputy governor Paul Tucker claimed this could not be.

It seems unlikely the BoE was not aware but we shouldn’t be so surprised banks would fudge the numbers in times of huge economic stress. People won’t like hearing this, but during the crisis banks were lending at such extremely high rates that if the real rates had been published, the whole crisis would have been pushed deeper into trouble, impacting trillions of dollars worth of debt contracts, and potentially killing off the bond markets.

Libor’s end

It has been reported banks are searching for a credible replacement to Libor as the benchmark comes under intense regulatory scrutiny. Some suggestions may have some credibility – basing an average on repurchase agreements, for example – but all will have flaws.

We should not give up on Libor. When it functions, it provides a stable and accurate credit reading.

Libor was born out of the need for companies to establish fair market lending rates. Traditionally a company would work with one bank to agree a rate with no idea whether that was the correct cost of funds or otherwise.

Then, to the credit of the banking industry, this system matured whereby a panel of banks would offer reference rates as a guide. This, in turn, then became the formalised process that we see today, where businesses can see a market average on a daily basis.

Libor’s weakness is that it is voluntary and based on trust. That trust is broken and it’s clear any subsequent regulation must reduce any opportunity for abuse and conflict of interest.

This is more important now than it has ever been. When banks were all rated with the same boilerplate credit ratings, the funding levels between them were not that different from each other. Now credit rating agencies have finally started making the effort to rate credit, this is no longer the case.

But how to do this?

There are no easy answers to this but one option would be to make submitting lending data a legal obligation for the rate setting process so banks can’t escape the duty. Establishing criteria, based on bank market activity and trade volume would be a good start. The more banks involved the less opportunity for collusion.

Substantial penalties would then need to be in place for banks caught manipulating interbank rates and criminal proceedings for the individuals involved.  This would not reduce the financial benefit for manipulation but it would dampen the appetite for it.

A second option - and by far the more dramatic - would be to reconsider splitting investment banking from normal commercial and retail banking activity. The UK’s Independent Commission on Banking originally proposed this but the British government thought otherwise. But that was before the Libor scandal erupted.

This proposal would certainly purify the well - relinquishing the pressure on bank’s treasury teams to play along with the needs of investment bank traders - but it could also reduce the number of banks able to provide Libor and would also make funding far more expensive.

But when trillions of deals are benchmarked against Libor big decisions need to be made to protect it.