Can UBS Bounce Back from the Rogue-Trader Scandal?

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Suspected rogue trader Kweku Adoboli leaving the City of London magistrates court, in London, Britain, 16 September 2011

When UBS announced last week that it has lost billions thanks to the antics of a rogue trader, the Swiss bank probably thought things couldn't get much worse. But on Sunday, there was more bad news: the beleaguered bank's losses, first estimated at $2 billion, are actually closer to $2.3 billion.

While Kweku Adoboli, the London-based investment banker responsible for UBS's pain, remains in custody until a hearing on Sept. 22, UBS explained in a statement on Sunday that it had only realized just how much it had lost because "the true magnitude of the risk exposure was distorted [by] fictitious trades." The bank added that no client funds were involved. To add insult to injury, the bank had recently announced that it would cut 3,500 jobs to save $2 billion; now these losses will wipe out any potential savings.

The rogue-trader scandal is just the latest in a string of misfortunes that have struck Switzerland's largest bank in the past few years. During the global financial crisis, UBS lost tens of billions due to its exposure to the toxic subprime market in the U.S. In 2009, the bank, one of the world's largest wealth managers, paid the U.S. government a $780 million fine to avoid criminal charges for helping rich Americans hide $20 billion from the IRS in undisclosed offshore accounts. "For a bank that has made mistakes in the past, this [new scandal] is absolutely unacceptable," Fulvio Pelli, president of the Radical Party, a member of Switzerland's seven-party coalition government, told the Swiss Broadcasting Corporation last week.

Given UBS's spotty past, experts say that restoring credibility to the once reputable financial powerhouse will take a major overhaul. First and foremost, "UBS would need a long period without any scandals and embezzlements," says Teodoro Cocca, adjunct professor at the Swiss Finance Institute and asset-management expert at the University of Linz, Austria. "It needs to prove to investors and clients that it can deliver stable earnings over an entire business cycle." Cocca also advocates separating UBS's investment activities from its private banking. "The investment sector is clearly a risk factor — not a return factor — for the entire group," he says. "Time has come to question this entire business model."

Stephane Garelli, professor at the Institute of Management Development in Lausanne, says that, in its present form, UBS no longer meets its clients' requirements. "Most people want a bank to be a safe place for their savings," he says. "Very few people care about exotic financial instruments like exchange-traded funds." While this latest scandal once again puts UBS in an unfavorable light, Garelli points out that no global bank is immune to similar abuses. "It raises the question of whether it's possible at all to have an effective risk-control system in a large universal bank — Swiss or not," he says. "What happened at UBS could happen tomorrow in another bank."

Looking ahead, Garelli predicts that governments will increasingly advocate splitting large banks according to the risk level of their activities. "The picture that emerges is one of a profound rethinking of the legislation controlling large universal banks, including international coordination," he says. "The fundamental idea is to insulate traditional core business from more risky operations." Others have had the same idea. Just days before the UBS trading scandal erupted, Britain's Independent Commission on Banking recommended that banks separate their conventional banking services from their riskier investment operations. In Switzerland, legislators are already debating a set of new banking regulations that would force UBS, as well as Switzerland's second-largest bank, Credit Suisse, to have the minimum reserve capital of at least 19% — more than required by international regulations, in order to cover any future losses.

In the meantime, UBS's chief executive Oswald Grueber told Sonntag newspaper on Sunday that he would not heed calls for his resignation because "when someone decides to act with criminal energy, you can't do anything about it. This will always exist in our job." For all the regulations and protective measures already in place and yet to be implemented, Cocca agrees that there is no foolproof way to prevent misuses in the banking sector. "We can't do much against it. If you are a big global player you have to accept this kind of risks," he says. "If you want to reduce that risk substantially, you have to quit the business."

How UBS decides to deal with this latest scandal — whether it will scale back its risky ventures or try another tactic — may be revealed on Nov. 17, when it announces future strategy to its investors. For now, though, the massive loss of money and reputation is, literally, breaking the bank.