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Italy third largest bank heads for state bailout

media Monte dei Paschi di Siena is the oldest bank in the world. REUTERS/Alessandro Bianchi

Troubled Italian bank, Monde dei Paschi di Siena, appears to be heading towards a state bailout. This comes after the lender launched a plan earlier this week to raise five billion euros in new capital.

What’s going on with the Italian banking sector? The short answer is, it's in deep trouble.

Monte dei Paschi is at the centre of a crisis in Italy's banking sector which is buckling under the weight of bad loans estimated to total 360 billion euros.

The lender is Italy's third-largest bank and has only enough funding for another four months. It risks being wound down by European regulators if it cannot clear a mountain of bad loans and find 5 billion euros in fresh capital.

"It's very likely that in the next two or three months, the bank will run out of cash," says Economist Yanni Koutsomitis. "Its situation is deteriorating quite rapidly."

This explains why Monte dei Paschi launched a last ditch plan at the beginning of the week, which appears to have failed.

What's the Italian government doing?

Some doubted the Italian State would be able to do much, given the financial situation of the country: the country has 133% debt-to-GDP ratio.

But the Italian parliament approved on Wednesday a 20 billion euros safety net for the banking system and the new government is now poised to present its own rescue plan as early as tonight.

"I think it's good news," said Lorenzo Codogno, Founder of LC Macro Advisors Limited. "It puts an end to a very long soap opera so to speak".

The plan could mean shareholders and holders of junior bonds, a risky class of debt, must contribute to saving the bank. Just over 40,000 private individuals hold BMPS bonds.

The government is keen to avoid a repetition of scenes sparked by last year's rescue of four small banks that led to heavy losses for small savers, prompting demonstrations and at least one suicide.

"Taxpayers won't be heavily involved because the government is investing, nationalising the bank in a way," notes Codogno. "The bank might be re-privatise in the next few years".

Does this mean the crisis is over?

Not just yet ... Four other banks might need rescue in the near future. Many experts have also warned a bank crisis in Italy could have negative consequences on the rest of the Eurozone.

However Yanni Koutsomitis explains that he doesn't expect things to spiral out of control: "This is a very remote possibility. I believe that the Italian and European authorities would jump in before any such risk were to occur."

The government still has to present its own rescue plan. Italian financial newspaper Il Sole 24 Ore said the bailout plan could take two to three months.

It would need to satisfy EU rules that require private investors to suffer losses before taxpayer funds can be used to save a bank.

"Monte dei Paschi is the big fish, it's the third bank in the country,' said Lorenzo Codogno. "So I think once you fix it, then the big chunk of the problem will be gone. There are others bank that could pose a problem, but they are much smaller, so much more manageable."

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