By Sarah White and Huw Jones
LONDON May 10 Former Bundesbank head Axel Weber warned on Thursday that policymakers had yet to truly tackle root problems in the euro zone, including Spain's troubled banking system.
Weber said a hard default by Greece was "not off the table", and that Spain's economy and its banking sector carried a very high contagion risk for Italy and the rest of the euro zone.
"Any renewed escalation of the crisis is also likely to come home to roost even in Germany," Weber, now chairman of UBS , told an Economist conference in London.
Recent central bank steps to stabilise the region, such as the European Central Bank (ECB) loaning cheap money to banks, were only short-term fixes, he said.
"These actions have only bought time," said Weber, formerly an ECB member. "We seem to have lost a year in terms of dealing with the underlying problems."
The Spanish government effectively took over one of the country's biggest banks, Bankia SA on Wednesday in its latest attempt to fix its financial sector, crippled by a property crash.
The ECB has lent a trillion euros at a low interest rate to banks across the European Union to help them with funding when markets are leery of investing in banks.
Weber said policymakers should look at other tried and tested measures such as bond guarantees and ringfencing certain assets on banks' balance sheets, as interventions thus far may only help in the short term.
"It could even be counter-productive in the long term as it incentivises many of the banks not to address the problems," he said.
Weber, a hawk when at the ECB, also warned that fiscal expansion policies were a "poisoned chalice" - sending a warning shot to France's newly elected president, Francois Hollande, who is calling for the EU to focus more on growth than austerity.
"It's a recipe for disaster rather than for a solution," Weber said.
Weber, who will have to steer UBS through its capital raising efforts as well as handle shareholder pressure over limp returns and high pay, said banks faced big challenges in raising capital in the market and that the only real option was to sell off assets and rein in lending.
He also said he had kicked off a dialogue with shareholders upset at pay levels at the Swiss bank to align remuneration with returns in a way they would see as fair.
More than one third of UBS's shareholders last week rejected the bank's pay plans, including a 4 million Swiss franc ($4.31 million) signing-on fee for Weber.
"I've started from day one an outreach process with shareholders and our employees," Weber said, adding that this was to reach a model that would balance stakes for UBS workers and owners in a fairer way.
He called for "regulatory certainty" on the introduction of tougher global bank capital rules, saying lenders needed this to embark on a journey to different business models.
Although not asking for a delay in new rules, he noted that the Group of 20 top economies (G20) had agreed that the changes should be phased in as economic recovery is assured -- a phrasing Germany had pushed for -- and that economies were once again in trouble.
Banks also lacked a "global level playing field" in areas such as use of hybrid debt in capital buffers.
Without mutual recognition of differing rules on hybrid debt global banks like UBS will be forced to have much higher capital buffers to comply with different jurisdictions, Weber said.