Will the LIBOR scandal be the one to take down the banking system?

As the LIBOR scandal evolves, analysts who at least at first thought it wasn't a huge deal have been backpedaling, and those who recognised it for the far-reaching mess that it is have been proved right. The proof of the importance of any issue is how it affects the involved parties' bottom lines, and it looks like Barclays bottom is beginning to smart.

The English city of Leicester has removed its US$9 million worth of deposits from the bank, and the Japan Bank for International Cooperation left Barclays out in the cold on its latest bond deal. The bank had worked with Barclays in the past on such projects, which have produced spectacular fees for England's third largest bank. In both cases, the reasons given for the snubs had to do with the LIBOR debacle.

Other banks are getting nervous
So far, Barclays has paid more than US$450 million in fines for its involvement in the scandal, and the effect on its business may cause other banks to step up damage control. Deutsche Bank has offered up evidence of its own malfeasance in hopes of securing reduced fines, and UBS (NYSE: UBS) is in good stead as the first bank to admit wrongdoing as the scandal began to unfold earlier this year.

American banks will be grilled, as well. Well over a year ago, The Wall Street Journal reported that regulators were eyeing Bank of America (NYSE: BAC) and Citigroup (NYSE: C) for their parts in possible LIBOR rigging for the years 2006-2008, so it certainly seems likely that they will once again questioned. JPMorgan Chase (NYSE: JPM), already under scrutiny for its trading problems, sat on the LIBOR panel during that time and will doubtless join B of A and Citi on the hot seat. Goldman Sachs and Morgan Stanley (NYSE: MS), however, are sitting pretty right now, since so far they seem not to have been involved in the scandal and may be in line to pick up investment business from other banks as contracts are lost because of tarnished reputations.

Fool's take
It has taken quite a long time for the scandal to balloon to its current proportions, and I have no doubt that it will draw in many more financial entities as its tentacles spread. Banks are certainly no strangers to scandal, but this one promises to turn the entire sector on its head. Could this turn out to be as serious a problem as the 2008 financial crisis? It looks possible, even probable, with one important difference: Regulators are handing out fines this time, instead of bailouts. If this latest instance of apparent malfeasance drives business to smaller competitors, banks just might just be solving the "too-big-to-fail" problem themselves.