EXCLUSIVE-Germany treads cautiously with bank reform plan

* German draft law to go to cabinet in February

* Plans would limit risk-taking, not lead to breakups

* German banks lobbied hard against radical steps

* Opposition seen attacking plan in election year

BERLIN, Jan 30 (Reuters) - Germany is opting for a modest reform of its banking sector that puts a cap on risky activities but would not lead to the breakup of banks or significantly impact big institutions like flagship lender Deutsche Bank, according to a draft law seen by Reuters.

The draft from the German finance ministry, which is expected to go to the cabinet for approval next month, would compel traditional lenders to separate proprietary trading, but only when the assets associated with these risky activities exceed 100 billion euros or 20 percent of the balance sheet.

According to the 64-page document, lenders would also be allowed to continue to trade on behalf of clients, engage in market-making and conduct treasury activities, although Germany's financial watchdog Bafin would receive powers to separate market-making in special cases.

Direct lending and provision of guarantees to hedge funds and private equity funds would be forbidden for retail banks, as would high-frequency trading with super-fast computers.

The new rules would come into force in January 2014, although banks would be given until July 2015 to separate their risky trading activities.

In addition to the cabinet, the Bundestag lower house of parliament would have to approve the rules in order for them to become law.

The proposals drafted by Wolfgang Schaeuble's ministry are similar to those unveiled by the French President Francois Hollande's government in December, and will come as a relief to big German banks, which lobbied actively to prevent more radical steps.

Based on estimates from experts, the risky trading ceiling set out in the draft law could affect up to three German institutions -- Deutsche Bank, Commerzbank und Landesbank LBBW.

The banks have stated however that they no longer engage in pure proprietary trading -- risk-taking in financial markets with their own money -- meaning the impact could be even more limited.

The opposition Social Democrats (SPD), led by former finance minister and chancellor candidate Peer Steinbrueck, unveiled proposals last year that would force banks to split their retail and investment banking units, as well as set up their own sector-wide rescue fund.

The SPD is likely to attack the softer approach taken by Chancellor Angela Merkel's government in the run-up to a September federal election.

The government's proposals echo recommendations made in October by a European Union advisory group led by Erkki Liikanen.

The "Volcker Rule" in the United States also aims to crack down on risky proprietary trading activities that got banks in trouble during the global financial crisis of 2008-2009, forcing government bailouts on both sides of the Atlantic.

(Writing by Noah Barkin)