There is, in UBS's London-based derivatives business, a hole of unknown, but possibly huge, proportions. Insiders are guessing at the size of these losses, but at present they reckon that UBS may have lost perhaps SFr1 billion ($689m). The rock on which UBS ran aground seems to be the same as that which sank Barings, Britain's oldest bank, in 1995: the failure to separate the responsibilities of the people who win business from the responsibilities of those who check how risky it is.

UBS has been under pressure for years from its largest shareholder, BK Vision, a fund run by Martin Ebner. Mr Ebner has long warned against the efforts of Mr Cabiallavetta, the chief executive, and the bank's chairman, Robert Studer, to build UBS into a trading powerhouse. ''We have always been against banks speculating for themselves. We have always pushed them to concentrate on offering services to their clients,'' says Kurt Schiltnecht, Mr Ebner's right-hand man. But UBS appears to have ignored their advice.

Crown jewel

Indeed, in its annual report for 1996, UBS crowed that its global equity derivatives division was one of the biggest jewels in its crown: ''Equities and, in particular, equity derivatives reported substantially higher trading income.'' The bank even won an award for its success at equity derivatives, which include everything from options on individual shares to creating instruments that mimic the behaviour of baskets of stocks. Competitors and insiders alike were surprised that UBS won almost every deal that it bid for. UBS did a particularly large amount of business selling long-dated options. Rivals openly wondered whether UBS was garnering so much business by selling its wares too cheaply. At least one bank went so far as to tell UBS informally of its worries. ''Either these guys had found a new way of pricing options, or they were just plain wrong'' reckons an executive there.

Mispricing is no small sin in the derivatives business. In cash trading for stocks or bonds, pricing errors are revealed almost immediately, so losses are limited. Derivatives contracts, however, can run for several years. They can sit on a bank's books, all but unnoticed, while losses build up. And if a faulty computer model leads a bank to make deals at too low a price, the problem is likely to afflict an entire series of trades, rather than just a single transaction. This is why, when losses are reported, the amounts are often stunningly large.

Last summer, partly as a result of these warnings, UBS sent a senior executive to London to see if anything was wrong. There were already signs that there might be. The global equity derivatives division had already lost heavily last July (as, to be fair, had other investment banks), when the British government unexpectedly changed tax rules so that investment banks could no longer claim tax relief on dividends if shares are held for trading rather than investment.

But UBS found problems, it now transpires, on an altogether grander scale. In November it reported a SF200m loss and sacked Rami Goldstein, the head of the global equity derivatives division, and a handful of others. Mr Goldstein's boss, Hans-Peter Bauer, who was in charge of fixed income, currency and derivatives trading, went by the wayside just before Christmas.

A team of bankers is now investigating what Mr Goldstein and his colleagues were up to. By the end of January, sources say, it had not even managed to find out how many trades the global equity derivatives division had done. A UBS spokesman said that the bank has established the extent of its losses, but other sources said that this is untrue. Its trading in Japan has proven particularly difficult to disentangle. What was wrong remains conjecture: UBS has kept mum, in part because many of its positions are still open.

One reason for UBS's problems stands out glaringly. It seems to have ignored the lessons of two recent derivatives disasters, the Barings collapse and the problems which forced NatWest, a British bank, to write off $120m in 1997. Barings was brought down by Nick Leeson, a trader in Singapore who, in addition to dealing futures and options, was allowed to settle his own trades and thus hide the riskiness of the very trades that he had entered into. NatWest took a hit because the values of the derivatives in the bank's portfolio were not checked properly with independent sources.

For all UBS's size, its risk control seems to have been equally flawed. For risk-management purposes, the global equity derivatives division was ring-fenced: no one else within UBS was allowed to check what was going on within it. The division's boss, Mr Bauer, was responsible not only for ensuring that the division made money, but also for ensuring that it did not engage in excessive risk-taking to do so. He had, in short, a conflict of interest.

Such conflicts seem to have been an institutional flaw at UBS. Pierre de Weck, the board member in charge of lending to risky credits, was also in charge of assessing their creditworthiness; Werner Bonadurer, the board member in charge of selling derivatives, was also responsible for managing financial-market risks. Neither, apparently, was able to take the merest peek at what the global equity derivatives division was up to. It appears that no single individual was in a position to monitor the entire institution's risks. UBS denies that this was the case, but it declines to discuss its risk management.

Strangely enough, that conflict of interest does not seem to have been resolved in planning for the new joint bank. Of the big responsibilities at the new bank, only one has been given to executives from Union Bank of Switzerland. This is Risk Control, which is to be headed by UBS veterans Felix Fischer and Mr de Weck. Stranger still, Mr de Weck will also be in charge of venture capital, which means that he is responsible for both the profits of such transactions and for assessing their riskiness.

The Economist January 31st 1998.

..... AND TEN YEARS LATER, October 2008:

Swiss Back Up Banks With Aid, Guarantees
Government to Own Stake in Giant UBS

Washington Post, Friday, October 17, 2008

After insisting for weeks that its world-famous financial system was holding strong in the global financial storm, Switzerland on Thursday became the latest country to announce extraordinary, multibillion-dollar bailout plans. UBS, the country's biggest bank, is transferring $60 billion in toxic debt to a new fund overseen by the Swiss central bank. The government is also investing $5.3 billion to take a 9.3 percent ownership interest in the bank.

In SwissInfo.ch, an online journal, same date, Rudolf Strahm, a finance expert and former Swiss Federal price regulator, comments:

The biggest insecurity in the system is that the banks assess their own risks. This opened the door to manipulation. UBS is a case in point. Before the beginning of the crisis, it calculated its credit risk at SFr800 million. Now it has to write down SFr40 billion – that's 50 times more. In other words, this risk measure is wide open to manipulation.

Back to Kurt Schiltnecht, spokesman for BK Vision, in 1998 UBS' largest shareholder: ''We have always been against banks speculating for themselves. We have always pushed UBS to concentrate on offering services to their clients.''

You may think - "Well, it's the banks' money anyway". Wrong.

The money banks lend is created by them under the authority of the Central Bank and ultimately Government which gives it legal validity. It is a national resource. Indeed it is one of the nation's most valuable resources with enormous potential for economic development. Currently it is abused and mis-used. We need it to work.

Find out

• how banks create money
• why there are so few banking controls
• and how we can put the nation's credit flow to better use.