UPDATE 3-Hollande unveils softened French bank reform
* Critics say bill falls short of pledge to fight finance
* Banks must ring-fence prop trading entities by 2015
* Moscovici says could be model for Germany, others
* Bank guarantee fund to rise to 10 billion euros
* Organised backlash in parliament seen as unlikely
By Lionel Laurent
PARIS, Dec 19 (Reuters) - France unveiled a long-awaited bank reform, hailing it as a model for the rest of Europe even as critics said it fell short of President Francois Hollande's campaign pledge to get tough with the financial sector.
The overhaul - which asks banks to house their proprietary trading units in separate, self-funded entities - will leave most of French lenders' investment banking activities untouched, ha n ding a victory to BNP Paribas, Societe Generale and other banks, after months of intense lobbying.
It is closer in spirit to the U.S. "Volcker Rule" - a complex attempt at cracking down on banks' prop trading - than the more radical U.K. reform recommended by the Vickers Commission aimed at getting banks to shield retail activities to avoid a repeat of the 2008 financial crisis.
By keeping French banks' combined model of commercial and investment banking intact, the government has tilted the law's balance in favour of keeping credit flowing to the stagnant French economy as opposed to stringent financial regulation.
"I did not want to weaken the French banking system. I want it to be strong," said French Finance Minister Pierre Moscovici.
He told a news conference the plan could even point the way for similar laws elsewhere in Europe, adding that Germany was also considering a similar reform.
Bank of France head Christian Noyer, speaking late on Tuesday, defended the plan, calling it "optimal" for France's economy, which has been stagnating in recent quarters and may end the year in decline, recent figures suggest.
The French Bank Federation said the reform would "create additional costs" that would make it more difficult to lend, saying banks were already under pressure to meet tougher post-crisis Basel III capital and liquidity requirements.
There was little market reaction, with BNP Paribas shares up 1.5 percent, Credit Agricole gaining 2.1 percent and Societe Generale 0.1 percent higher, compared with a 1.4 percent sectoral gain at 1600 GMT.
Under the terms of the draft law, banks will have to ring-fence proprietary trading activities in separate, self-funded entities by 2015, while sparing activities such as market-making, hedging and private-equity financing. Regulatory oversight of these activities will be ramped up.
The ring-fenced entities will be banned from high-frequency trading and commodity derivatives trading.
In principle, this is not far removed from recommendations made in October by a European Union advisory group led by Erkki Liikanen which called for the ring-fencing of a swathe of trading activities.
Still, critics say France's reform defines prop trading so narrowly that it leaves much of the riskiness of banks intact, such as sizeable derivatives portfolios and funding of risky investment vehicles.
"It's ultimately a minimal reform, without much impact on banking activities and without major upheaval in the way they're operated," said Natixis analyst Alex Koagne.
Moscovici said the reform would affect 10 percent of big banks' capital markets revenue.
"This is worse than a backtrack," said Jerome Cazes, former head of Natixis credit-insurance unit Coface. "It is the minimum you can put in a law without blowing a raspberry to the public."
BNP Paribas only derives about 1 percent of investment-banking revenues from proprietary trading, one of its top executives told reporters recently. It is likely some banks will decide to scrap these businesses entirely.
The reform also encompasses other measures including a fund to rescue ailing banks and guarantee their deposits which Moscovici said would rise to 10 billion euros ($13.21 billion) in 2020 from an initial 2 billion, as well as tougher enforcement powers and consumer protection.
It remains unclear whether disappointment among those looking for more radical reform from the Socialist government will translate into an organised backlash in parliament - which is due to debate the law early next year - or among the public.
That looks unlikely at a time when France is struggling with stagnant growth, an unemployment rate at its highest in 13 years and a pullback in bank credit as lenders across Europe slim down to meet incoming post-crisis Basel III capital requirements.
"We are in a phase of economic slowdown and anything that can be done to keep the flow of credit to companies is in line with the public interest," said Philippe Marini, the centre-right UMP party's banking expert in the French Senate.
"Any new rules or split of activities that goes too far would likely have a harmful economic impact ... The Socialist government has come back down to earth."
Socialist lawmakers and senators have defended the proposals, saying they will keep banks in line and protect taxpayers from the cost of bailing them out while, at the same time, protecting the stagnant economy from a body blow.
"We want an economy that works, that creates jobs and that has functioning companies," said Socialist Senator Richard Yung. "We also want banks to do their job of lending to the economy." ($1 = 0.7568 euros) (Additional reporting by Matthieu Protard; Editing by Dan Lalor and Helen Massy-Beresford)