Accident-prone Barclays in need of miracle

London BriefingOnly a miracle can save Barclays' bid for Dutch bank ABN Amro from ignominious defeat at the hands of the rival RBS-led consortium. While that will clearly be a severe blow to Barclays' corporate pride, not to mention its strategy, it is not the most pressing problem facing Britain's third-biggest bank.

The past fortnight has been one of the most difficult faced so far by Barclays, which has been forced to come out fighting against rumours that it has suffered a multimillion-pound hit in the escalating sub-prime contagion that has been sweeping through the global financial system this summer.

There was a brief respite for the bank earlier this week, as its battered shares responded positively to reassuring interviews in the weekend press with Bob Diamond, president of the bank and head of its investment banking division, Barclays Capital.

"We are weathering the storm," Diamond told the Sunday Telegraph.

"It's not a bail-out," he barked at the Sunday Times, referring to the $1.4 billion (€1.03 billion) refinancing of a troubled debt vehicle created for Cairn Capital, the London-based hedge fund.

Cairn Capital is just one of a series of problems that has emerged at Barclays in the past fortnight - it has twice been forced to tap into the Bank of England's emergency lending facility, borrowing £1.6 billion (€2.37 billion) at a penal interest rate of 6.75 per cent, a move it later blamed on a "technical breakdown" in the British clearing system.

It has also faced questions - and massive publicity - over the abrupt departure of Edward Cahill (33), European head of collateralised debt obligations at Barclays Capital.

Cahill's departure from the bank further fuelled rumours of a crisis, with some of the more panicked stories even suggesting he could be the new Nick Leeson, the man who brought down Barings Bank.

Such alarmist reports have been denied by Barclays and Cahill, who appears to have quit his loft apartment in London's docklands but is apparently serving out his notice with Barclays. He has also employed leading libel lawyers Mishcon de Reya to quash any suggestions that he may have acted improperly.

Diamond insists that Barclays' exposure to "SIV-lite", the controversial structured investment vehicles at the centre of the market turmoil, is limited to about £75 million.

However, while the Barclays president has finally raised his head above the parapet, the bank's senior management has come under fire for not moving to reassure the market before some of the wilder rumours did the rounds.

It is all a far cry from the widespread applause that greeted the bank's China coup little more than six weeks ago, when it secured a £2.4 billion investment from China Development Bank and Temasek, the investment arm of the Singaporean government.

Under the terms of the agreement, the two will invest a further £6.5 billion in Barclays if the ABN takeover goes through.

That was in late July, and Barclays shares responded with a leap to 745p. The travails of the past few weeks, however, pushed its price down below the 600p level at one stage, although it has since recovered to about 640p.

For its paper-heavy ABN offer to succeed, Barclays needs its shares to be trading at close to 800p by early next month.

That was a tall order even before the recent crisis. Now, with its new-found reputation for being accident prone, it looks virtually impossible.

Old Lady urged to act

The Bank of England (BoE) was commended for its cool approach when the sub-prime crisis first broke, remaining resolutely on the sidelines as the US Federal Reserve, the European Central Bank and others moved to inject huge amounts of liquidity into the money markets in an effort to restore calm.

Behind the lack of activity at the BoE is the permanent and unlimited facility it introduced last year for banks to draw on as and when they need to. The 6.75 per cent charged for such funds - a full point above current base rate - contrasts markedly with the other central banks' injection of cheap funds into the system.

Now, however, the banks are increasingly calling for action from the Old Lady following a dramatic squeeze on liquidity that has seen short-term lending rates in the money market jump to their highest levels since 1998, with the three-month London interbank offered rate (Libor) reaching almost 6.8 per cent yesterday.

This is the rate at which banks are prepared to lend to each other on an unsecured basis and effectively means they are now unwilling to advance funds except at premium rates, for fear of where the next sub-prime shock might emerge.

To the outsider, the interbank rate might appear to be one of the City's more esoteric indicators but, if these conditions continue, it will have a serious knock-on effect on the wider economy, as the banks pass their higher borrowing costs on to consumers in the form of higher mortgage rates.

BoE governor Mervyn King has made it clear he does not see it as the duty of the bank to protect financial institutions from the consequences of irresponsible lending. Once homeowners start to feel the pinch, though, he may find the calls for action harder to resist.

Fiona Walsh writes for theGuardian newspaper in London