Banca Monte Dei Paschi Di Siena SpA Headquarters And Bank Branches...Pedestrians stand and talk outside a Banca Monte dei Paschi di Siena SpA bank branch in Siena, Italy, on Tuesday, March 11, 2014. Banca Monte dei Paschi di Siena SpA, the bailed out Italian bank seeking to raise 3 billion euros ($4.2 billion) in a share sale, reported a seventh straight quarterly loss on provisions and restructuring costs. Photographer: Alessia Pierdomenico/Bloomberg
Founded in 1472, Monte Paschi has weighed on the Italian financial system since the financial crisis © Bloomberg

The world’s oldest bank, which has been cleaned up twice by Italian authorities, has been told by the European Central Bank it needs to shed another €10bn in bad loans, sparking fresh worries over the health of the troubled Italian banking sector.

Shares in Monte dei Paschi di Siena, founded in 1472 and Italy’s third-largest lender, dropped 13 per cent on Monday to an all-time low after it disclosed the ECB warning, dragging down all of the country’s largest lenders.

UniCredit, Italy’s only globally systemic bank, was down 3.8 per cent and also hit an all-time low. The FTSE Italia All-Share Banks index was down 3.7 per cent. It has lost nearly 56 per cent of its value this year. All told, the sector is weighed down by about €360bn in non-performing loans, by far the largest in the eurozone.

Monte dei Paschi also faces stress-test results due to be published at the end of July, according to senior bankers.

After the plunge in bank capitalisations so far this year, bankers expect Monte dei Paschi may be requested to boost its capital — a situation that will prove difficult for the bank.

Unlike Spain and Ireland, which were forced into international bailout programmes when they proved unable to fund multibillion-euro clean-ups of their banking sectors at the height of the eurozone crisis, Italy has never conducted a root-and-branch overhaul of its financial institutions.

Eurozone officials have begun to worry that Italian banks may emerge as the weak link in their six-year effort to shore up the EU’s common currency. The turmoil unleashed by Britain’s vote to leave the EU has underscored those concerns by turning the spotlight back on the eurozone’s still-incomplete foundations.

With a debt level that is second highest in the eurozone after Greece, the Italian government itself is strapped for cash and EU officials worry Rome would struggle to fund a rescue.

Still, Matteo Renzi, the Italian prime minister, has begun to weigh whether to bypass new crisis-era EU banking rules to bail out the sector using public funds. Under EU rules, such bailouts are now illegal unless creditors bear the brunt of a bank rescue — meaning Italian depositors could be on the hook.

Fabrizio Viola, a well respected chief executive brought in to oversee Monte dei Paschi three years ago, has slashed costs and improved governance but has been unable to make any significant inroads into its vast pile of non-performing loans.

Two previous attempts to bail the bank out using state-backed bonds and four capital rises failed to revive the lender amid complaints about mismanagement and fraud.

Monte dei Paschi said the ECB had demanded that gross non-performing loans be cut from €46.9bn at the end of 2015 to €38.9bn at the end of 2017 and €32.6bn by the end of 2018.

On a net level, the draft letter from the ECB said non-performing loans needed to be reduced from €24.4bn in 2015 to €18.4bn in 2017 and €14.6bn by 2018.

State-owned bank Cassa Depositi e Prestiti and Atlante, a government sponsored but privately-backed rescue fund, met on Monday to discuss the situation. Brussels has mooted a potential conversion of its junior debt to equity in a bailout scenario.

Mr Renzi hopes to find a market solution for Italy’s banks. Atlante is due to launch a non-performing loans fund in the next few days that will focus on buying up Monte dei Paschi’s holdings for a price closer to book value, according to senior bankers.

As a last resort, Italy would be willing to pump billions of euros into its banks to stem a systemic crisis in defiance of the EU, say people familiar with the government’s thinking.

Capital hikes worth a combined €2.5bn at regional banks Popolare di Vicenza and Veneto Banca in the past two months attracted little interest from investors and had to be backstopped by the Atlante fund.

“The bank has immediately initiated discussions with the European Central Bank in order to understand all the indications included in this draft letter, and to present its reasoning before the final decision, expected by the end of July 2016,” Monte dei Paschi said.

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