Exclusive - EU presidency wants to ditch ban on proprietary trading at banks

By Huw Jones

LONDON (Reuters) - European Union plans to ban banks taking market bets with their own money should be scrapped to avoid crimping the flow of funds needed for economic recovery, an EU document showed on Tuesday.

The bloc's executive European Commission has proposed a draft law to ban proprietary trading at banks and force lenders to isolate other forms of risky trading to help keep the financial system stable.

Latvia, current holder of the EU presidency, in its first full proposal to revise the draft law, wants to ditch the ban in the latest sign of how policymakers' attention is switching from regulation to reviving growth.

"The changes reflect the fact that there is a mandatory separation of proprietary trading rather than a ban," the document seen by Reuters said.

Even then, trading would have to trigger a host of quantitative and qualitative criteria for identifying excessive risks before actual separation would take place, meaning separation would not be automatic but down to supervisory discretion, the document added.

"Excessive risks are identified only after balancing the risks against the benefits to the real economy for market making," the document said.

Banks have warned that structural separation would exacerbate already thinning liquidity in some markets which policymakers are increasingly concerned about.

The watering down of the Commission's draft law is backed by several member states, including France.

"The debate on framing has to be envisaged in the broader context of the overall objectives of the regulation, in particular reducing excessive risks of trading activities and ensuring an appropriate treatment of market making, in line with the ECB opinion," France said in comments to the EU presidency.

The European Central Bank (ECB) has said the draft law should not harm the flow of funds to the economy from useful market-making, or whereby banks enable investors to buy and sell securities.

Daniele Nouy, who chairs the ECB's supervisory arm that regulates top euro zone lenders and will apply the new rules, told EU lawmakers on Tuesday they should be "very careful about market-making, which helps businesses fund themselves".

"The supervisor needs to have some margin of manoeuvre, nothing should be fully automatic, whatever criteria is used, as it's better for when it comes to financing our economies," Nouy told the European Parliament's economic affairs committee, which has joint say with EU states on the draft rules.

"It's better for when it comes to financing our economies... for supervisors to decide on a case-by-case basis," she added.

Latvia also proposes other changes, such as allowing a bank to own a trading entity, though subject to some limits on the organisational structure if deemed necessary.

Some EU lawmakers worry the final law will end up being a far cry from the Commission's original intention.

"It looks like we are not going to get anywhere near that point," Philippe Lamberts, a Green party lawmaker, told the economic affairs committee

Britain has already decided to force banks from 2019 to legally separate retail arms from risky trading, and a banking official said the UK is now worried that without "automaticity", it could be challenged by lenders over EU rules that give regulators discretion.

(Reporting by Huw Jones; editing by Jason Neely and David Evans)