President Barack Obama proposed stricter limits on financial institutions' risk-taking on Thursday in a new populist-tinged move that sent bank shares tumbling and aimed to shore up the president's political base.

Obama, a Democrat who is just starting his second year in office, laid out rules to prevent banks or financial institutions that own banks from investing in, owning or sponsoring a hedge fund or private equity fund.

He also called for a new cap on the size of banks in relation to the overall financial sector that would take into account not only bank deposits, which are already capped, but also liabilities and other non-deposit funding sources.

We should no longer allow banks to stray too far from their central mission of serving their customers, Obama told reporters, flanked by his top economic advisers and lawmakers.

Too many financial firms have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments to reap a quick reward.

The rules, which must be agreed by Congress, would also bar institutions from proprietary trading operations, unrelated to serving customers, for their own profit.

Proprietary trading involves a firm making bets on financial markets with its own money, rather than executing a trade for a client. These expert trading operations, which can bet on stocks and other financial instruments to rise or fall, have been enormously profitable for the banks but also increase market volatility.

The White House blames the practice for helping to nearly bring down the U.S. financial system in 2008.

Obama's move is the latest in a series to crack down on banks and comes as he reels from a devastating political loss for his Democratic Party in Massachusetts on Tuesday, when a Republican captured a U.S. senate seat formerly held by the late Democratic senator Edward Kennedy.

Bank shares slid and the dollar fell against other currencies after Obama's announcement.

JPMorgan Chase & Co fell 5.8 percent, helping push the Dow Jones Industrial average lower.

Citigroup Inc fell 6.36 percent and Bank of America Corp fell 7 percent while Goldman was down 5.5 percent despite posting strong earnings Thursday.


This is going to have a tremendous impact on big-name brokerage firms like Goldman Sachs and JPMorgan, said Ralph Fogel, investment strategist at Fogel Neale Partners in New York.

If they stop prop trading, it will not only dry up liquidity in the market, but it will change the whole structure of Wall Street, of the whole trading community.

Obama targeted banks for taking big risks while assuming taxpayers would bail them out if they failed.

When banks benefit from the safety net that taxpayers provide, which includes lower-cost capital, it is not appropriate for them to turn around and use that cheap money to trade for profit, Obama said.

That is especially true when this kind of trading often puts banks in direct conflict with their customers' interests, he said.

Before the announcement, Obama met with Paul Volcker, the former Federal Reserve chairman who heads his economic recovery advisory board and who favors putting curbs on big financial firms to limit their ability to do harm.

The House of Representatives approved a sweeping financial regulation reform bill on December 11.

The House bill contains a provision that empowers regulators to restrict proprietary trading by financial firms subjected to stricter oversight because they are judged to pose a risk to the stability of the financial system.

The Senate has not yet acted on the matter, but the Senate Banking Committee continues to seek bipartisan agreement on financial regulation reform.

(additional reporting by Caren Bohan, Ross Colvin, Matt Spetalnick and Alister Bull, editing by Philip Barbara)