Police in London said they arrested a 31-year-old UBS trader, Kweku Adoboli, in the alleged fraud. UBS declined to confirm his name.
Switzerland's largest bank warned that it could report a loss for the entire third quarter as a result of the rogue trade, while shares in UBS AG plummeted 8.7 per cent to 9.98 francs ($11.41) on the Zurich exchange by mid afternoon.
The case immediately evoked memories of Jerome Kerviel, the trader at French bank Societe Generale who secretly gambled away €4.9 billion ($6.7 billion). The scale of that fraud rocked the global financial industry and prompted banks to tighten oversight rules to ensure such large sums couldn't be traded unnoticed.
The Swiss banking regulator Finma said it was in contact with UBS about the incident, which was discovered late Wednesday.
"From the scale of this case you can be sure that it's the biggest we've ever seen for a Swiss bank," Finma spokesman Tobias Lux told The Associated Press.
UBS provided little specific information, saying the incident was still under investigation and no client money was involved. The unauthorized transactions could cost UBS almost as much as the 2 billion Swiss francs ($2.28 billion) the bank hopes to save by cutting 3,500 jobs over the next two years.
It comes as UBS is struggling to restore its reputation after heavy subprime losses during the financial crisis that resulted in a government bailout, and an embarrassing U.S. tax evasion case that blew a hole in Switzerland's storied tradition of banking secrecy.
Peter Thorne, a London-based equities analyst at Helvea, said the loss was financially manageable for UBS. But he said it was a blow to the reputation of UBS and its management, and will likely add to calls for the bank to slim down its investment banking unit.
Adoboli's profile on the professional networking site LinkedIn showed he spent the past five years working at UBS's European Equity Trading division after three years as a trade support analyst for the bank.
He graduated from the University of Nottingham in 2003 with a degree in E-commerce and digital business, the university said.
According to Philip Octave, Adoboli's former landlord, he lived in an expensive loft on Brune Street for several years before moving out about 4 1/2 months ago. The area is near London's Brick Lane, a busy street of curry houses, bars and vintage fashion shops only a few blocks from UBS's U.K. headquarters.
Octave described Adoboli as a well-dressed quiet man of African origin who "was not the tidiest" of people but very well spoken.
He fell behind in the rent twice but always paid up in the end, Octave said, adding that his rent was a hefty 4,000 pounds per month (US$6,320). He said he asked him to move out so he could refurbish the apartment.
"He was not a party chap," Octave said. "I found no problems."
Adoboli's profile picture on Facebook showed a black-and-white photograph of an African man in his early 30s, with interests including photography, cycling and boutique wines. The profile became unavailable hours after Adoboli's arrest, indicating that someone with the password had removed it.
Banking observers immediately highlighted the similarities to the Kerviel case, which also involved a trader in his early thirties entrusted with responsibility for vast sums of money.
The debacle that befell Societe Generale, France's second-largest bank, resulted in Kerviel being convicted in October 2010 on charges of forgery, breach of trust and unauthorized computer use for covering up bets worth nearly €50 billion ($68 billion) between late 2007 and early 2008. He was ordered to pay the bank back all the money he had lost and banned for life from working in the financial industry. Kerviel has appealed the verdict.
By coincidence, the Swiss parliament began a long-slated debate on the future of the country's banking industry Thursday.
Lawmakers are being asked to consider proposals to ensure that Switzerland's two biggest banks — UBS and Credit Suisse Group — are brought under tighter control as they are considered "too big to fail." Some lawmakers have called for investment banks to be split off from the core business, to ensure they can't bring down the whole company in case of sudden unexpected losses.
In a terse statement shortly before markets opened Thursday, UBS informed investors that "UBS has discovered a loss due to unauthorized trading by a trader in its investment bank."
"UBS's current estimate of the loss on the trades is in the range of $2 billion," it added. "It is possible that this could lead UBS to report a loss for the third quarter of 2011."
In a letter sent to its employees, the bank said it regretted that the incident came at a difficult time.
"While the news is distressing, it will not change the fundamental strength of our firm," the note said. "''We urge you to stay focused on your clients, who are counting on you to guide them through these uncertain times."
UBS chief executive Oswald Gruebel recently warned that the bank wouldn't achieve its aim for a pretax profit of 15 billion francs a year by 2014. UBS earned some 2.8 billion francs during the first half of the year, with the investment bank contributing 1.2 billion before tax.
UBS has been pressing to restore its reputation after suffering huge losses relating to toxic debts in the United States and needing a $60 billion bailout from the Swiss government.
"The real issue ... over and above the financial impact is the reflection on risk management at UBS," said Fionna Swaffield, banks analyst at RBC Capital Markets.
"UBS was seen to have recovered significantly from the credit crisis and to have improved its risk management in the investment bank in spite of its struggle to improve returns. This obviously brings this very much into question."
In other trading debacles, Nick Leeson, a British trader working in Singapore for Barings Bank, made unauthorized futures trades that lost more than $1 billion and led to the venerable bank's collapse in 1995. The infamous case prompted banks worldwide to tighten their internal checks.
Leeson was released from a Singapore jail in 1998 for good behaviour after serving 3 1/2 years of a 6 1/2-year sentence. He claimed he did not make a cent from his disastrous trades but Barings' liquidators sought the return of 100 million pounds on any of his earnings relating to Barings.
Jordans contributed from Geneva. John Heilprin in Geneva, and Bob Barr, Greg Katz, Raphael G. Satter and Pan Pylas in London contributed to this report.