PARIS France's planned banking reform will severely curb banks' proprietary trading while avoiding moves that might restrict the flow of credit to the economy, Finance Minister Pierre Moscovici said on Thursday.
The government is preparing to unveil a draft law in mid-December that aims to crack down on banks' risky trading, which was a campaign pledge of President Francois Hollande.
Banks will have to create a separate entity to house activities deemed to be risky and would have to outline a resolution mechanism in case they have to be wound down in a crisis, said Moscovici.
Regulatory oversight will also be ramped up.
"I want this reform to profoundly change the sector," Moscovici told a conference on Thursday. "It will separate speculative activities from those that are useful for the economy."
The reform is being drafted after European proposals by the Liikanen Commission called for a ring-fencing of nearly all types of trading, including market-making where a bank quotes buy and sell prices at which it will trade specific securities.
Reuters earlier reported that the French reform was expected to spare market-making, according to two sources briefed on the government's position.
Moscovici insisted the reform would not spell the end in France of large so-called universal banks - with activities ranging from retail lending to trading in financial markets - nor harm banks' services to their corporate clients.
Societe Generale (SOGN.PA) Chief Executive Frederic Oudea said the speech showed the reform would be demanding without compromising banks' business models.
"It is the confirmation of a demanding reform," Oudea told reporters on the sidelines of the conference. "I note, however, that our trading activities will not be thrown out wholesale."
Proprietary trading, where banks take risks in financial markets with their own money, is under the spotlight because it can expose banks to big losses.
Around 5 to 10 percent of capital-markets revenue in 2011 was estimated to be proprietary-related at BNP (BNPP.PA) and SocGen, the two biggest investment banks in France.
Banks have already cut back proprietary trading in anticipation of tougher rules, which echo measures in other centers. In Britain for instance the Independent Commission on Banking under John Vickers recommended UK banks shield or "ring-fence" their retail operations from riskier investment banking activities.
The French Banking Federation said in a statement following Moscovici's speech that banks' ability to lend to the economy should not be harmed and that foreign banks should not benefit from the incoming law.
"(It must) not distort competition within the European market, or between Europe and the United States," it said.
French banks have only just emerged from a year of shedding assets and cutting staff to slim down their balance sheets to prepare for tougher capital requirements under Basel III rules.
But BNP Paribas (BNPP.PA) Chairman Baudouin Prot said a recent U.S. decision to delay application of Basel III risked creating a trend whereby Europe tightens the regulatory noose around its banks while other jurisdictions hold back.
"Europe is taking the wrong road," said Prot, who became chairman last year after almost a decade running France's No. 1 bank. "The U.S. economy, which created the crisis with subprime debt, has still not regulated its mortgage market."
A full split of trading activities from retail and other types of banking could cost 6 to 10 percent of profits at France's top banks, according to analysts at Citigroup.
However, if the scope is restricted to proprietary trading, the impact would be "marginal", they said. ($1 = 0.7856 euros)
(Editing by David Holmes and Helen Massy-Beresford)