Questionable Risk Controls Cost UBS More than Rogue Trades

The announcement by UBS ( UBS ) earlier today that unauthorized trades by a bank employee could wipe off $2 billion in value could weigh on the bank's stock with serious concerns being raised about the bank's risk management system. With UBS initiating an investigation into the matter, the $2 billion figure quoted is based on initial estimates of losses accumulated from a series of trades by the rogue trader identified as working for the bank's equity trading division in London. While the bank ascertained that the trades did not affect any of its clients, it has indicated that the single event would result in its reporting a loss for this quarter. UBS competes with rivals such as Morgan Stanley ( MS ), JPMorgan ( JPM ), Credit Suisse ( CS ), and Goldman Sachs ( GS ).

We have a near $20 price estimate for UBS , which is noticeably ahead of the current market price. We attribute the price difference to the market's negative sentiments over the growing European debt crisis compounded by uncertainty over the impact of the U.S. debt rating downgrade.

Investment Banking Revenues were already expected lower this quarter…

Extreme volatility in the financial markets, largely due to the European debt crisis and the downgrade of the U.S. long-term debt rating, are already expected to hit the trading revenues of large investment banks. JPMorgan was the first to stick out its neck and announce a decline in trading revenues by as much as 30% this quarter over the numbers in Q2 2011 (See JP Morgan Trading Revenues 30% Lower This Quarter ). And Morgan Stanley followed suit with a similar announcement.

Large banks are expected to report their Q3 earnings beginning mid-October.

… and this incident reveals bigger problems with the bank's operations

While the announcement that the unauthorized trades will send the bank into the red for this quarter is bad enough, the fact that a single rogue employee could wipe out such a significant amount of UBS' value indicates serious issues with the bank's internal practices. The appalling conclusion drawn is that employee controls and risk-management procedures would practically be non-existent in the bank. With the bank focusing on cutting costs in the recent past, it also seems to be cutting corners by overlooking industry-wide necessary standards for risk-management. This incident would very well mean that the bank will have to revamp its internal controls to ensure no repeats in the future.

See our full analysis of UBS

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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