'AN epitaph for an age of irresponsibility", is how the Chancellor, George Osborne, described the Barclays Libor-fixing scandal in the Commons last week.

It was, he went on, "symptomatic of a financial system that elevated greed above all other concerns and brought our economy to its knees". If even a Tory chancellor has finally got it, can we expect real action to sort out Britain's banks? Don't hold your breath.

The manipulation of Libor – the London Inter-Bank Offered Rate – has been common knowledge in financial circles for years. The Economist has been writing about it at least since 2008. The idea that the British Bankers Association didn't know what has been going on is laughable. Every barrow-boy in the City knew the banks had been fiddling their borrowing costs in order to disguise their distress after Lehman Brothers crashed in 2008 and inter-bank lending almost froze. By manipulating their borrowing costs, banks like Barclays were able to convey the impression that they were in less financial stress than they actually were.

Imagine you are someone with a poor credit rating, who loses their job. No-one wants to lend to you because you are a bad risk. But you have a mate in the credit-rating agency who, for a bottle of Bollinger, will fiddle it so your credit rating is triple-A. This means you can borrow money to buy a big house. Then it's off to the races. That's not how it worked in reality, but you get the idea.

Fixing Libor is far worse, of course, than fiddling a person's credit rating because this lending rate is the basis on which many mortgage payments and loans to business are calculated, as well as those scary financial derivatives that are worth a staggering $500 trillion, according to the Bank of International Settlement.

In a very real sense this is the banks against the people, for this was not one rogue trader in one bank. It seems likely that most of the very big banks were in on the scam. It would appear RBS may be in the frame over Libor manipulation, and the company is bracing itself for regulatory retribution.

Interest-rate manipulation is fraud. Yet, in the looking-glass world of banking it is regarded as a "victimless crime" and largely unpunished. Hence the presumption that the people with ultimate responsibility, such as Barclays chief executive Bob Diamond, will somehow be immune from prosecution, though his company has been fined £290m by the Financial Services Authority. Not just too big to fail, but too big to jail.

Diamond denies, of course, that he knew anything about the Libor manipulation. This is no defence because, as the man in charge, his job is to know what's going on. It's what he gets paid £18 million a year for. George Osborne promised that the Government would look at "criminal sanctions for directors of failed banks where there is proven criminal negligence". Let's hope he's true to his words. According to the Financial Times, the Serious Fraud Office decided not to investigate the Libor affair because it regarded it as a low priority. Well, it's not too late to change your minds, guys.

Putting bankers behind bars is only the start. We can no longer allow private banks to set financial benchmarks like Libor because the temptation to cheat is simply too great. The bonus culture encourages irresponsible, reckless and illegal behaviour because the rewards are so huge. But what is even worse is the temptation for banks, and not just their employees, to manipulate the system to conceal their financial position from the regulators.

The case for separating investment or "casino" banking from plain deposit banking is now unanswerable. The Vickers Commission looked into this last year and recommended the two should be "ring-fenced", but not until 2019 at the earliest. Sorry, but we simply cannot wait that long.

A consequence of this separation of investment banking is that casino banks that lose their bets must be allowed to fail.

The central problem throughout the crisis has been that universal banks the size of Barclays, which has a balance sheet as large as the UK economy, cannot be allowed to fail because they would bring down the entire financial system. This is what has corroded standards in financial services. There is no penalty for screwing things up.

After 2008, the Bank of England's rescue of the banking sector required £1 trillion of taxpayer's money, according to its governor, Sir Mervyn King. This bailed out the banks without reforming them. Never again. A financial transactions tax, as proposed by the EU but rejected by the UK, should be levied on banking activities to provide a fund to cope with the fallout from future bank failures.

The bankers owe their very livelihoods to the generosity of the British public, yet they have continued to behave badly, their bonuses growing ever larger as the rest of the country suffers the consequences of their recklessness. Those bonuses, earned by people like Bob Diamond, should now be forfeited. Since they were based on manipulation of interest rates, they are surely illegitimate proceeds of fraud.

There have already been numerous Commons inquiries, an FSA inquiry and the Vickers Commission into the behaviour of banks. But until the whole truth is known, the public cannot have confidence in the financial system.

The countless scandals that have hit the City in recent years – payment protection insurance, endowment mortgages, sub-prime lending and now interest-rate fixing – have exposed the regulatory authorities as inadequate to the task.

What we really need is a kind of truth-and-reconciliation commission, in which whistle-blowers can be offered immunity from prosecution if they expose what has been going on in the financial cesspit called the City. For this is the worst lesson of this latest crisis: what we know is bad enough, but what we don't know is almost certainly far worse.

Successive governments have, at all levels, been compromised by association with the big banks. Financial institutions give donations to political parties, provide financial expertise to hard-pressed ministers and offer highly paid jobs to senior politicians and civil servants when they leave office. Tony Blair left Number 10 and walked straight into a lucrative position with JP Morgan bank on a reported salary of £2m. Under Gordon Brown, Number 10 was filled with special advisers from the financial sector, including Baroness Shriti Vadera of UBS.

Indeed, there is a strong argument that we no longer live in a liberal democracy, but in something like a welfare state for the banks – though with one important difference: when claimants defraud the benefits system they are prosecuted. People like Diamond lecture us on the merits of the free market, yet this has nothing whatever to do with free markets or even capitalism.

This is kleptocracy – rule by a rapacious financial elite. They must be stopped, society must respond, or else we risk becoming like Russia, ruled by financial oligarchs without a shred of social responsibility.

Jailing them should be just the start ...

ANALYSIS BY IAIN MACWHIRTER