WHEN John Varley was appointed chief executive of Barclays in October 2003, many in the City gossiped that Bob Diamond, head of the Barclays Capital investment bank, would quit within months.

Diamond had lost out in the battle for the top slot and, for the sceptics, it was only a matter of time before boardroom intrigue and tension between the two executives became too much.

After all, no other big British bank was headed by two such powerful figures. Observers suggested Varley would feel threatened by Diamond, who in 2006 was paid £22m – almost seven times the sum pocketed by his boss.

Instead, Varley and Diamond appear to have struck up a constructive, although at times uneasy, partnership.

The two are radically different. Varley is an establishment figure, with a penchant for wearing old-fashioned suits with high-waisted trousers and braces.

Educated at Downside, the private Catholic school, and Oriel College, Oxford, the 51-year-old qualified solicitor has spent most of his career at Barclays. He has strong links with the bank’s past through his marriage to Carolyn, a member of the Pease family that sold their bank to Barclays in 1902.

Diamond, 56, is the hard-charg-ing American who switched from teaching university students to investment banking in 1979.

An avid sports fan, he has decorated his office with memorabilia of his beloved Boston Red Sox baseball team and Chelsea football club. In contrast, Varley’s office is austere.

Diamond is outgoing and likes attending big sports events and presenting the trophies, but Varley, a devout Catholic, does not seek a high public profile.

On the surface the relationship has worked. Since Varley formally took over as chief executive in September 2004, Barclays has racked up record profits and set itself a bold target of becoming the world’s leading universal bank.

But as Barclays prepares to announce its 2007 results on Tuesday, there are rumblings in the City of fresh tensions at Britain’s third-biggest bank.

Varley and Diamond are both under intense pressure after 12 turbulent months. Varley has seen his bid to take over Dutch bank ABN Amro trumped by a consortium led by Royal Bank of Scotland, thwarting his ambition to make Barclays one of the world’s top five banks.

Meanwhile, the shockwaves from the American sub-prime mortgage crisis have prompted fears of further hefty write-offs at Barclays Capital and doubts about whether the investment-bank powerhouse can sustain its explosive profit growth.

Diamond’s empire, which spans Barclays Capital, fund manager Barclays Global Investors and wealth management, has been the engine of the group’s earnings. The three divisions accounted for 54% or £2.2 billion of Barclays’ overall £4.1 billion pretax profits in the first half of 2007. In contrast, growth has been pedestrian in UK banking and international retail and commercial banking.

As a result, the leadership questions have never really gone away. In the summer of 2006, analysts at Dresdner Kleinwort suggested in a provocatively titled note “Bob Diamond 3, John Varley 0”, that the American banker was in effect taking the top job by stealth.

Undoubtedly, Diamond has been given leeway by Varley.

“Varley agreed to give Bob a lot of autonomy, but the quid pro quo to having a long leash was the ability to yank it if he stepped too far outside his territory,” said one banker.

However, Varley also appears to have given Diamond considerable power at the heart of the overall group.

What is less well known is that in 2006 Varley took the unusual step of handing Diamond responsibility for Barclays’ “inorganic strategy”, in effect mergers and acquisitions.

Later that year, Diamond was also put in control of the Barclays brand. Potentially this gave him immense power because he could wield influence over the marketing position of all the group’s individual businesses.

Varley has consistently said that he wanted to replicate the drive and creativity of Barclays Capital across the group. Yet just how much extra power Diamond gained is debatable. Observers point out that he may have been in charge of inorganic strategy, but that he played only a minor role to Varley in the wooing of ABN.

One interpretation is that Varley gave Diamond such roles as a distraction and to prevent a power struggle. Sources close to the bank argue this is far too crude a view.

Instead of being threatened by Diamond, the quietly self-confi-dent Varley recognised how he could use his rival’s talent and underline his pledge to turn the bank into a true meritocracy.

“John is so analytical that he does not really fear things. He keeps his ego in check and is not emotional. He is disciplined and very precise,” said one friend.

“A lot of the so-called rivalry is based on misunderstanding by outsiders. They work extremely well together,” added another friend.

Even so, there have been clashes. Varley is understood to have been frustrated by what one observer calls “game playing” and occasionally by Diamond’s high profile.

One area of tension is understood to be planning for life after Diamond at Barclays Capital. In 2005, Varley pushed the succession issue and, under pressure from the board, Diamond agreed to make Jerry del Missier and Grant Kvalheim co-presidents.

Kvalheim became the latest casualty of the credit crunch last month when he was ousted after Barclays took a £1.3 billion hit linked to the sub-prime crisis. That left Del Missier in pole position to succeed Diamond.

Varley is also understood to have been irked by some of Diamond’s comments during the battle to take over ABN. “Bob on occasion looked as if he was acting like a virtual chief exec and there was a feeling that he was overstepping his territory,” said one banker.

What makes unravelling the delicate relationship between Varley and Diamond fascinating is the influence of other senior executives. Varley, an unlikely radical, has dramatically overhauled the bank’s senior ranks, luring highly paid American bankers to take charge of international retail and commercial banking, credit cards and retail banks.

The biggest new gorilla in the boardroom is Frits Seegers, a heavyweight Citigroup banker, hired in June 2006 to the new role of chief executive of global retail and commercial banking. His appointment was widely seen as a move to counterbalance Diamond’s power.

Equally significantly, Marcus Agius, the former Lazard investment banker, has arrived as chairman. Though Agius is naturally impressed by Barclays Capital’s stellar profit growth, he is also thought to have raised some concerns that the investment bank relies too much on proprietary trading.

Nobody questions that Diamond has built an investment-banking powerhouse virtually from scratch in 12 remarkable years, but he has lost his “golden boy” status.

Barclays Capital made a record £1.9 billion profit for the first 10 months of 2007. But investors will demand reassurance at this week’s results that Diamond has stabilised the business. Some sources believe that the results will impress and defy the gloom mongers.

Rumours persist that some board members are increasingly nervous. “The support for Bob has become more fragile. Too many on the board see too much risk written over his forehead,” said one source.

For many, the past six months have seen a marked shift in power to Varley. That has also sparked rumours that Diamond may leave this year, though not before he can claim a controversial £14.8m special incentive. Last year wild rumours were strenuously denied that he had resigned or had stormed out of a board meeting.

Diamond is thought to have been annoyed that he was not considered for either of the top jobs at Citi or Merrill Lynch, though a chance to lead another top-notch investment bank may yet emerge.

A switch into politics in an advisory role has also been rumoured. Diamond, a strong Republican, is passionate about politics.

Such a move would end a remarkable investment-banking career and bring the curtain down on an odd but profitable partnership. Diamond, as a baseball fan, knows he is stepping up to the plate and everyone is watching.

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