* Banks made mistakes, but politicians to blame
* Excessive crisis avoidance can cause new crises
(Adds background, more quotes)
By Emma Thomasson
ZURICH, Sept 10 (Reuters) - UBS AG Chairman Kaspar Villiger warned against overreacting to the financial crisis with too much regulation, saying that while banks made mistakes, politicians should take most of the blame.
Villiger, a former Swiss finance minister brought in as UBS chairman earlier this year after the government bailed out the bank, was speaking at a conference on restoring trust in financial markets.
"Many banks have made inexcusable mistakes. However these mistakes are not the cause of the crisis. The markets have not failed, they have reacted logically to the misguided incentives set by politicians, in particular (in) the U.S.," he said.
Villiger said factors that drove the crisis included low U.S. interest rates, U.S. political pressure to promote mortgages to low earners and pro-cyclical accounting rules.
He said there was now a tendency to over-regulate financial markets because policymakers believed that management of the financial system by the market had failed and that greed and incompetence of bankers was at the heart of the crisis.
"There is now the risk that due to the incorrect diagnosis of the causes of the crisis, the patient will be administered the incorrect medicine for too long which may significantly worsen global growth prospects," he said.
"The time has come to again fight for a market economy."
G20 finance ministers meeting at the weekend said excessive bank pay and risk-taking were at the root of the crisis but only made vague compromises over precise plans to force banks to rein in bonuses and build buffers against any future crisis.
FORESTS NEED FIRES
Villiger echoed comments made by Goldman Sachs Chief Executive LLoyd Blankfein on Wednesday in which he urged policymakers to refrain from creating a system "designed solely around protecting us from the 100-year storm."
He said as forests needed occasional fires to thrive, economies needed recessions to stay competitive: "Excessive crisis avoidance can lead to other crises," Villiger said.
He cited a study that showed banks might have been better capitalised without regulator-imposed capital requirements as it would have forced them to work out for themselves capital needs and not rely on a state seal of approval.
"Perhaps it would have turned out better if there had been less regulation," he said.
But he added he was not against new Swiss rules to demand stronger capital levels and control bonuses, as long as they did not put Swiss banks at an international disadvantage.
UBS said last year it was axing bonuses for top executives and linking future payouts to the bank's results but it has faced criticism for recent big hikes in pay for investment bankers to retain key staff after the bonus cut.
Swiss financial regulator FINMA is demanding banks link staff bonus plans to long-term performance and is requiring UBS and Credit Suisse to shore up their capital base to at least 1.5 times minimum international standards by 2013. (Editing by David Holmes and Simon Jessop)