(Refiles to correct date to July 6)
By Steve Slater
LONDON, July 6 (Reuters) - Barclays investment banking boss Rich Ricci was in tears when he addressed his traders after the sudden exit of CEO Bob Diamond this week, as a rate-rigging scandal puts the future of his business on uncertain ground.
Ricci was shaken by the sudden exits of Diamond and his other good friend Jerry del Missier. But he also knows their departures herald big change for his investment bank.
An interest rate rigging scandal at Barclays makes the separation or shrinking of its investment banking arm more likely, given greater regulatory and political intrusion and the exit of the trio of investment bankers at the top of the bank.
"The shareholder and political pressures on Barclays ... could lead to broader pressure on the bank to shift its business model away from investment banking and reform perceived failures in its business culture," ratings agency Moody's said on Thursday, threatening to cut its credit ratings.
"The case for separation grows," said Neil Dwane, chief investment officer Europe for Allianz Global Investors, citing a "cultural problem of entitlement to bonus and risk-taking" and also the management risks.
"(There is) clear evidence in the U.S. and UK that these banks are nearly impossible to manage, orientated to the wrong corporate objectives and still overseen by managers who bust the world and their industry five years ago," said Dwane, whose firm holds Barclays shares.
Founded 320 years ago by London Quakers, Barclays branched out of traditional banking to expand aggressively into investment banking in recent years, led by Diamond, a hard-charging American chief of the investment bank and later CEO.
In 2008 it completed its transformation into a trans-Atlantic investment banking giant by buying the U.S. assets of bankrupt Lehman Brothers. Its investment banking arm, strong in debt markets, is now the seventh biggest in the world and second biggest in Europe, with first quarter revenues of 3.5 billion pounds ($5.4 billion).
The investment bank's 3 billion pound profit last year represented 53 percent of the Barclays total.
But regulators have been uneasy. It emerged this week that Britain's financial regulator warned the Barclays board in February that its culture was too aggressive and must change.
In the latest scandal, Barclays was fined a record $450 million by U.S. and UK regulators for rigging interbank interest rates between 2005 and 2009.
Diamond resigned on Tuesday under what sources say was pressure from the Bank of England and the financial regulator. Chairman Marcus Agius, an ex-investment banker at Lazard, will also leave, and Jerry del Missier, co-head of investment banking until last month and then chief operating officer, also quit.
More than a dozen other banks are also being probed as part of the rate rigging investigation and many are expected to be fined, but for now Barclays is standing alone in the centre of the latest storm over standards in investment banking.
The industry was already reshaping under pressure as profits have been squeezed from holding more capital for their activities, the euro zone crisis cuts revenues and shareholders want banker pay cut. British banks must separate and "ring-fence" domestic retail banking from riskier areas.
But in the current environment, a sale or a spin-off of the investment bank might attract few suitors or investors, with depressed valuations and limited appetite for bank stock.
There are also unrealistic expectations on how easy it would be to separate the investment arm, one senior banker said.
There are still big capital benefits from running a diversified, universal bank, and the practical considerations of separation for funding, capital, systems and contracts are huge.
Much will depend on who takes over as CEO or chairman and how keen UK authorities are to influence the bank.
"Probably whoever comes in will try to reduce the scale of the investment bank and look to address the division of compensation and rewards for shareholders, which are not in equilibrium," the senior banker said.
Mike Trippitt, analyst at Oriel, said the investment bank could be wound down: "The departure of Bob Diamond should dispel much of the emotive issue associated with a revision of management's strategy away from investment banking."
Yet others note it is the board that sets the strategy so there shouldn't be an abrupt sea-change.
Talk of splitting Barclays and moving the investment bank to New York is not new, but in the past it has been because investors have said the value of the investment bank is not reflected in the share price of the group.
Four months ago Diamond shifted in the opposite direction, dropping the Barclays Capital name for the investment bank under a plan to align all businesses under "One Barclays".
Now, morale is low and bankers know it could take time to restore the bank's reputation.
"I ask you now to step up with me to that challenge," Ricci told staff in an email seen by Reuters.
Ricci, a no-nonsense American who joined Barclays in 1994, has always preferred to let Diamond do BarCap's talking and is more at home on a race course.
Barclays entered investment banking with Prime Minister Margaret Thatcher's "Big Bang" deregulation of the British financial industry in 1986, acquiring small houses to form BZW, an investment arm.
Diamond, del Missier and Ricci led a 16-year build-up of Barclays Capital formed out of the ashes of BZW in 1997. Its equities and advisory units were sold and it focused on debt markets, before the opportunistic purchase of the U.S. arm of Lehman gave it new strength in equity and advisory, which it has been building out in Europe and Asia.
It ranks second in debt market revenues this year and for the last decade has fought with J.P.Morgan for top spot. It ranks sixth in advisory and ninth in equity market revenues this year, both up from 10th place in 2005, according to Thomson Reuters data.
A fund manager at one of the 40 biggest investors in the bank, asking not to be identified until the dust settles, said the threat that a new boss might give up on investment banking would be bad for shareholders, as that is where the bank can lift profitability.
"If you invest in Barclays you have to do so with your eyes open ... it needs a certain sort of character to run it."
($1 = 0.6443 British pounds) (Additional reporting by Anjuli Davies, Sinead Cruise and Chris Vellacott; Editing by Peter Graff)