UPDATE 2-EXCLUSIVE-Germany treads cautiously with bank reform
* German draft law to go to cabinet in February
* Plans would limit risk-taking, not lead to breakups
* German banks lobbied hard against radical steps
* Opposition attacks plan as election-year ploy (Adds quotes from SPD, banking association, draft law)
By Matthias Sobolewski and Noah Barkin
BERLIN, Jan 30 (Reuters) - Germany plans a modest reform of its banking sector that would put a cap on risky activities but not lead to the breakup of banks or significantly impair big institutions like flagship lender Deutsche Bank, according to a draft law seen by Reuters.
The 64-page bill from the finance ministry, which will be up for cabinet approval early next month, comes four months after an EU advisory group led by Finnish central banker Erkki Liikanen unveiled reform proposals to shield taxpayers and savers from bank collapses.
Mirroring a core recommendation of the Liikanen group, Germany would compel lenders to separate risky trading activities, but only when assets associated with them exceed 100 billion euros or 20 percent of the balance sheet.
That means a very limited number of institutions in Germany may be affected. The country's biggest banks, including Deutsche, say they are no longer engaged in the pure proprietary trading the law is designed to limit.
"The separation of risky trading activities from client business can secure the solvency of institutions and lead to a stabilisation of financial markets," the draft reads.
According to the document, lenders would be allowed to continue to trade on behalf of clients, conduct treasury activities and engage in market-making -- where financial institutions quote prices at which they will buy or sell securities.
Direct lending and the provision of guarantees to hedge funds and private equity funds would be forbidden for retail banks, as would high-frequency trading.
The new rules would come into force in January 2014, but banks would be given until the middle of next year to identify which of their activities fall into the risky category, and another year to separate the activities.
"It all comes down to the definition of proprietary trading. That is the real issue and we can expect more fighting over this," said Konrad Becker, an analyst at Merck Finck.
"Though even if Deutsche Bank has to separate out some activities, it will not hit them hard," he added, describing the impact as "very, very superficial".
German Chancellor Angela Merkel faces a battle for re-election this year and the centre-left opposition is hoping to portray her as soft on the bankers many blame for years of financial turmoil.
The Social Democrats (SPD), led by former finance minister and chancellor candidate Peer Steinbrueck, unveiled tougher proposals last year that would force banks to split their retail and investment banking units, as well as set up their own sector-wide rescue fund.
Lothar Binding, a finance expert for the SPD in parliament, described the government's proposals as a mere "placebo". His Greens counterpart Gerhard Schick said Merkel's coalition was putting the interests of banks above those of ordinary citizens.
The proposals drafted by Wolfgang Schaeuble's ministry must be approved by the Bundestag lower house of parliament to become law, but must not go through the Bundesrat upper house, where the opposition has a blocking majority.
The steps are similar to those unveiled by French President Francois Hollande's government in December, and will come as a relief to big German banks, which lobbied actively to prevent more radical measures.
Based on estimates from experts, the risky trading ceiling set out in the draft law could affect up to three German institutions -- Deutsche Bank, Commerzbank und Landesbank LBBW.
But much will depend on how risky activities are defined.
Jan Krahnen, director of the Center for Financial Studies at Goethe-University in Frankfurt and a member of the Liikanen group, criticised the draft law's focus on proprietary trading, saying it was difficult for regulators to distinguish this from other non-proprietary activities.
Michael Kemmer, head of German banking association BdB, chastised the government for coming up with proposals before a European Commission study on the impact of the Liikanen recommendations has been completed.
"Until now there is no proof that separating trading activities increases the stability of financial markets," Kemmer said. "There is therefore no need for this rushed legislative initiative," Kemmer said. (Additional reporting by Philipp Halstrick, Arno Schuetze and Alexander Huebner in Frankfurt; Writing by Noah Barkin)
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