UBS AG’s $2 billion trading loss may revive calls for Chief Executive Officer Oswald Gruebel to further shrink the investment bank.

Gruebel today called the loss “unauthorized” and “distressing” in an e-mail to employees, without giving details of how Switzerland’s biggest bank lost the money. A 31-year-old man was arrested in central London today, police said.

“Shareholders will be fuming,” said Chris Roebuck, a visiting professor at the Cass Business School in London. “It will yet again confirm to the majority of shareholders, who are Swiss, that investment banking is not ‘proper’ banking.”

The investment bank, which posted 57.1 billion Swiss francs ($65 billion) in cumulative pretax losses in the three years through 2009, has since struggled to match its peers’ gains from sales and trading, even after adding employees and increasing risk. The wealth management units, which generate 41 percent of UBS’s revenue, have been attracting net new money over the past year after clients pulled assets in the credit crisis.

“The key area of damage in our view is reputational and extends beyond the investment bank, into UBS’s private banking business,” analysts at Goldman Sachs Group Inc. led by Jernej Omahen wrote in a note to clients today. It “therefore adds to the long list of arguments and pressure for a substantially smaller investment bank.”

Lehman Anniversary

No client positions were affected, the Zurich-based company said in a statement today, the third anniversary of Lehman Brothers Holdings Inc.’s collapse. The loss, discovered yesterday afternoon, occurred in the bank’s equities unit in London, NZZ newspaper reported. UBS spokeswoman Tatiana Togni declined to comment beyond the bank’s statement.

The shares fell as much as 9.6 percent in Swiss trading, and were down 7.6 percent at 10.10 francs by 12:10 p.m., for a market value of 38.7 billion francs. The stock has dropped 34 percent this year.

Gruebel, who was brought out of retirement in February 2009, has sought to install tighter controls at the investment bank. After joining UBS, he started weekly calls with top risk officers and was personally monitoring traders’ positions together with Carsten Kengeter, who heads the investment bank.

Gruebel began his 37-year career at Credit Suisse, which he headed before retiring in 2007, at the bank’s Eurobond trading desk in 1970. By 1991, he had become head of global trading. Under his leadership, the Zurich-based bank started cutting its holdings of U.S. subprime mortgage bonds in 2006, when competitors -- including UBS -- were still buying them.

‘Digestible’

The loss amounts to about 4 percent of UBS’s tangible equity and 5 percent of its core Tier 1 capital, making it “large, but digestible,” the Goldman Sachs analysts said.

UBS said in July it won’t reach its target for pretax profit of 15 billion francs by 2014 and announced job cuts to revive earnings. The lender will publish the results of a review into the investment banking division in November.

“This could be a critical tipping point for UBS’s strategy,” said Simon Maughan, head of sales and distribution at MF Global Ltd. in London. The investment bank “looks unreformed, unwieldy and ultimately unsustainable.”

Analysts had suggested in July, when UBS announced the review, that the bank would scale back its investment bank to conserve capital and bolster profitability.

Gruebel, 67, and Kengeter, 44, have been trying to revive earnings at the unit for two years. They hired more than 1,700 people and brought in new divisional heads to replace those that departed. They’ve also increased risk-taking to bolster earnings.

Value-at-Risk

While competitors have been cutting risk, UBS has been increasing value at risk, a measure of potential trading losses on a given day. UBS’s average VaR for the second quarter climbed to 75 million francs, the highest since the fourth quarter of 2008, from 48 million francs in the year-earlier period.

By comparison, VaR at JP Morgan Chase & Co.’s investment bank dropped to $77 million from $90 million in the year-earlier period. At Deutsche Bank AG, the measure declined to 75 million euros in the second quarter, the lowest since the final three months of 2006.

Among the nine biggest investment banks, UBS’s share of revenue from trading stocks and bonds and advising clients on capital-market transactions and mergers more than doubled from 2009 to the first half of this year. Even so, it remained the lowest amongst its peers, data compiled by Bloomberg show.

The unit has suffered a series of departures in Europe and the U.S. Neal Shear, the Swiss bank’s head of global securities, quit in March, as did Dimitrios Psyllidis, co-head of fixed income. John Wall, a UBS veteran of more than 23 years and co- head of investment banking since September 2009, retired this year and Matthew Koder, head of the global capital-markets business, also left.