"This legislation deals with the small number of very large banks which otherwise might still be too-big-to-fail, too-costly-to save, too-complex-to-resolve," said Michel Barnier, the EU Commissioner in charge of financial market reform.
"The proposed measures will further strengthen financial stability and ensure taxpayers don't end up paying for the mistakes of banks," he added.
The regulation would cover the continent's 30 largest banks, which hold assets worth approximately 23.4 trillion euros ($32 trillion), according to EU Commission figures.
The legislation still needs to be approved by EU governments and the European Parliament and is likely to be subject to fierce lobbying over its fine print. It is not expected to take full effect before 2017 almost a decade after the collapse of Lehman Brothers in 2008 triggered the worst phase of the financial crisis.
The reform also aims to give regulators the power to separate banks' riskier trading activities from their deposit-taking business. The Commission said it had no estimate on how many banks would have to create such subsidiaries, which will require their own capital buffers.
European governments have injected about 1.6 trillion euros ($2.2 trillion) into their banks since the beginning of the financial crisis, or the equivalent of about 13 percent of the bloc's economic output, Barnier said.
The proprietary trading, which will be banned with only a few exceptions, represented up to 15 percent of banks' balance sheets before the financial crisis. It is now down to an estimated 4 percent of balance sheets, or about 940 billion euros, according to the Commission.
"There is a risk it will increase again once growth picks up," Barnier said.
One of the big challenges for regulators will be to distinguish proprietary trading, which will be banned, from other banking activities.
Europe's bank lobby group deplored the proposal, saying it might have "far-reaching consequences on banks' structure, daily business and organization" that could undermine lending and harm Europe's nascent economic recovery.
The rules would introduce "a prolonged uncertainty" that will weigh on the lenders' competitiveness and attractiveness to investors, the European Banking Federation said.
Center-left European Parliament lawmakers, in turn, argue the plan does "too little, too late" to curtail excessive risk-taking. They say all trading activities should be completely separated from retail operations.
The focus on the few largest banks means letting all small and mid-size banks, who make up the bulk of Europe's lenders, continue to "gamble with their client's money," said center-left caucus leader Hannes Swoboda.
Nations like France and Germany have sought to protect their biggest banks like Societe Generale and Deutsche Bank. They pressured the Commission to better isolate risky trading activities, but not force banks into being split in two separate entities, one for speculative trading operations and the other their retail business.
Banks in Britain, which is home to Europe's biggest financial hub, London, won't have to split off their riskier trading operations into subsidiaries since they already face equally tough national legislation called the Vickers rules, the Commission said.
The U.S. Volcker Rule is named for Paul Volcker, a former Federal Reserve chairman who advised President Barack Obama during the financial crisis.
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