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Exclusive: Germany, France attack EU plan to curb big banks

European flags are hung outside the European Commission headquarters in Brussels January 22, 2014. REUTERS/Yves Herman
European flags are hung outside the European Commission headquarters in Brussels January 22, 2014. REUTERS/Yves Herman

By Huw Jones

LONDON (Reuters) - Germany and France have attacked European Union plans to curb banks' ability to take market bets with their own money, warning that this could jeopardize a delicate economic recovery, a paper seen by Reuters showed.

Next week, the European Commission will unveil a blueprint to challenge the power of big banks, tackling one of the biggest risks exposed by the 2007-2009 financial crisis.

The paper does not bear an author's name but five financial industry and government sources told Reuters that Germany and France, together with Italy, were behind it.

It sends a warning shot from the euro zone's top economies to Brussels not to overstep the mark in a way that could challenge their national champions, such as Deutsche Bank or BNP Paribas .

It also underlines growing tensions with Brussels on financial reform, weeks after a proposal from Brussels to set up a system of banking union was watered down by EU members states, including Germany.

The European Commission is due to formally propose the draft law to rein in excessive trading risks on January 29, to apply lessons from the financial crisis that forced taxpayers to bail out lenders that had taken excessive risks.

Leaked versions of the draft law propose banning proprietary trading at banks above a certain size.

Proprietary trading refers to banks taking bets on markets with their own money rather than a client's. Other types of trading such as complex securitization and derivatives may also have to be separated from a bank's deposit-taking arm.

"This approach could result in a lot of activities useful for the financing of the economy ceasing to be provided by European banks and migrating to third country players or to the shadow banking system, jeopardizing the financing of the economy in a crucial recovery phase," the paper says.

Shadow banks refer to non-banking firms that deal in credit such as broker dealers and some hedge funds.

The German and French finance ministries declined to comment. Italy's representation in Brussels did not immediately respond to a request for comment.

FRAGMENT MARKET

Financial industry officials said the paper is widely seen as an attempt to fend off new rules that would prevent so-called universal banks from losing the benefits of having all operations under the same roof.

The paper said there were good arguments for preserving the universal banking model, adding that a ban on designated proprietary trading alone runs the risk of being ineffective.

"The draft regulation defines proprietary trading in nominal terms, without going into the detailed characterization which is necessary for effective implementation."

Instead, speculative activities could be separated on a "functional basis", the paper said - meaning rather than splitting up banks.

"In this context, we suggest a middle course according to which certain activities have to be separated (proprietary trading) while others (market making) should be subject to supervisory judgement based on the appropriate metrics, not automatic thresholds," the paper added.

National exemptions from having to separate non-proprietary trading could fragment the bloc's market, the paper added.

Germany and France are already introducing reforms to curb trading risks, but they are less strict than the EU plans, while Britain says its changes are at least as tough.

The draft law will have to be approved by EU states and the European Parliament before it becomes effective from 2017.

It will be Europe's counterpart to the Volcker Rule that takes effect in the United States in July 2015 to ban leading banks from proprietary trading and which is being challenged by banks in the courts.

(Additional reporting by John O'Donnell in Brussels, Mark John in Paris and Matthias Sobolewski in Berlin; Editing by Chris Vellacott and Pravin Char)

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