Faith in UBS Goes Rogue

UBS's admission that a trader has run up losses of $2 billion, from what the bank described as unauthorized trades, couldn't come at a worse time for the bank or the industry. The Swiss banking giant has been struggling to rebuild trust after running up vast losses in the original financial crisis.

Under Chief Executive Oswald Grübel, the bank said it put in place new risk-management practices, pulled back from proprietary trading and focused on a low-risk client-driven model. This incident will test the faith of investors, clients and regulators.

UBS isn't yet saying how the money was lost, although police in London arrested a man on suspicion of committing fraud, and a person familiar with the matter said the man was a UBS employee. But the mind boggles as to how UBS could have run up a loss equivalent to 28 times its second-quarter average daily value-at-risk via unauthorized trades.

Even in the current volatile markets when large swings can trigger big losses on unhedged positions, sizable trades appear to have gone undetected or at least been poorly understood. UBS says no client money was lost, but the fact the bank could become so exposed is alarming.

UBS can absorb the loss; it made a pretax profit of $1.9 billion in the second quarter alone. But the resumption in UBS's dividend, currently expected next year, must now be in question. More important, the rogue trades will raise questions about the future of UBS's investment bank. The market already doubted it would deliver returns on equity above its cost of capital under the new Basel and Swiss National Bank regulatory rules.

Indeed, the loss comes at a particularly sensitive time for all investment banks, in the wake of the U.K. banking commission's report recommending they be ring-fenced, or segregated, from retail banking. UBS will resist pressure to break itself up, not least because no one is likely to pay close to book value for the division and the cost of closing it would be huge. But this latest lapse in risk management is bound to fuel calls in Switzerland for reforms similar to those planned in the U.K., adding to the uncertainty over the long-term future of UBS's investment bank.

read more: Olympus Wealth Management