May 27 (Bloomberg) -- UBS AG, the Swiss bank which received government aid, will stick to a policy of paying market wages after being criticized for raising salaries at its investment bank, Chief Executive Officer Oswald Gruebel told employees.

“We have to pay our employees in line with the market,” Gruebel said in an internal memo to staff yesterday. “We will stick to this stance, even if it is criticized in the emotional debate over salaries.”

UBS is boosting salaries for senior bankers at its investment bank by an average of 50 percent to stem defections, three people with knowledge of the matter said earlier this month. The bank cut its bonus pool by 78 percent in January after amassing the biggest loss in Swiss corporate history in 2008 and turning to the government for help.

“Losing a few key people can decimate profits and destroy morale,” said James Carss, a Hong Kong-based recruiter at Hudson Global Resources. “Many individuals this year are unhappy with their reduced bonus and this ultimately gives them less loyalty to an organization.”

The “exceptional” salary increases “were necessary to safeguard our profitable business areas and to secure their success,” Gruebel said. “Following significant cuts in variable compensation, we had fallen well behind the market in certain areas, and that is unsustainable in the long run.”

To help retain senior bankers, UBS had also set aside about 900 million Swiss francs ($831 million) for bonus payments over the next three years under a plan to tie compensation to longer- term profitability. The payments depend on both the bank and the employee’s division being profitable, and on UBS accepting no further capital from the state, the company said in February.

‘Fundamental Change’

Departures at the securities unit this year include Rob Rankin, head of investment banking for the Asia-Pacific region, and Antoine Dresch, who co-ran European telecommunications and media banking. William O’Donnell, head of U.S. interest-rate strategy, also left the company, as did investment bankers Daniel Ward and Sten Gustafson. Alexander Ehrlich was hired by Morgan Stanley to oversee the prime brokerage business.

Gruebel, 65, who was hired out of retirement three months ago, has announced 7,500 job cuts and replaced investment- banking chief Jerker Johansson, 53, with Alexander Wilmot- Sitwell, 48, and Carsten Kengeter, 42.

“I firmly believe that the banking business will undergo fundamental change and will not just experience a sharp correction,” Gruebel said in the memo.

‘Right Direction’

UBS is “moving in the right direction” and now has to focus on analyzing client needs to be able to successfully seize opportunities, he said in the memo. The bank will continue to combine wealth management and Swiss business with a global investment bank and asset management operations, he reiterated.

Gruebel singled out the bank’s equities and foreign exchange trading for “untiring efforts to make our client service the best available,” and said the units “illustrate how we want to run our investment banking business in the future.”

UBS has amassed more than $53 billion in losses and writedowns in the financial crisis, more than any other European competitor, and had to raise more than $34 billion in fresh capital from investors, including the Swiss government. The bank posted a first-quarter loss of 1.98 billion francs ($1.83 billion) after markdowns tied to bond insurers and credit-loss provisions.

To contact the reporters on this story: Elena Logutenkova in Zurich at elogutenkova@bloomberg.net

Last Updated: May 27, 2009 00:29 EDT