By John O'Donnell
BRUSSELS (Reuters) - Europe unveiled a blueprint to isolate some risky trading at big banks on Wednesday, which critics dismissed as a limp challenge to their dominance.
After the collapse of Wall Street's Lehman Brothers in 2008, world leaders pledged to tackle banks that were "too big to fail". Yet throughout the crisis many of Europe's biggest banks continued to grow.
On Wednesday, the European Commission outlined its proposals for a new law to reform the way big banks take risks when trading.
Announcing the draft legislation Michel Barnier, the European commissioner responsible, said it represented "the final cogs in the wheel to complete the regulatory overhaul of the European banking system".
But as with many previous reforms, Wednesday's draft law has been tempered by industry lobbying.
The plan shies away from suggesting any splitting of big banks and opts instead for a ban on proprietary trading using their own funds, an activity that has already been much reduced.
It also suggests isolating other types of trading from the 'safe' side of banking - deposit taking - by creating subsidiaries. However, these will remain within the bank.
Even if agreement with countries and the European Parliament is reached, which is also in doubt, the rules will begin only by 2017 at the earliest - roughly a decade after the start of the banking crisis in Europe and some two years after similar action in the United States.
The foot-dragging illustrates the fading political will to push tougher reform in the face of opposition from Germany and France, both determined to protect their flagship lenders.
Wolfgang Schaeuble, Germany's finance minister, said earlier this week that he had urged the Commission to "think carefully" when drafting the new law.
Pressure from Paris and Berlin appears to have worked. Sven Giegold, an influential German lawmaker in the European Parliament, said Barnier had backed down.
"Barnier couldn't bring himself to go up against France and Germany," he said. "The resulting law is bureaucratic and ineffective. Rather than saying certain types of business should be separated, there are loads of exceptions."
He and others say the law will do little to address the vast scale of big banks, blamed for risky trading and growth in the multi-trillion dollar derivatives market.
Barnier said the proposal had been crafted to avoid any impact on lending to the real economy, a well-worn argument of the banking lobby.
This has become a catch-all reason to reduce regulation despite protest from public-interest groups who counter that most bank activity is now orientated around financial markets rather than loans.
The draft law draws on advice from a group led by Finnish central bank governor Erkki Liikanen.
He suggested mandatory separation of banks' trading with their own funds, and other market betting, into a different legal entity. It would have its own capital to cushion risks but would remain within the bank.
On this count, the EU draft law is set to go further, and, like the Volcker Rule in the United States, ban banks from such trading. The U.S. rule, however, applies to all banks, while in the EU it applies to lenders above a certain size, taking in the top 30 or so banks.
Crucially, the EU law stops short of physically breaking up big banks into retail and wholesale units, a step critics say is needed to remove the too-big-to-fail threat.
(Editing by Erica Billingham)