By John Geddie
LONDON, Dec 23 (Reuters) - Italian government bond yields fell on Friday as Monte dei Paschi said it would request aid from a newly-approved state fund to help struggling banks, after failing to win investor backing for a capital increase.
Ten-year yields slipped 4 basis points (bps) to 1.81 percent in thin trading before the Christmas holidays.
Another banking saga concluded with Germany's Deutsche Bank agreeing to a $7.2 billion settlement with the U.S. Department of Justice (DOJ) over toxic mortgage securities sold in the run-up to the 2008 financial crisis, nearly half the fine initially levied in September.
Elsewhere, Credit Suisse agreed to pay $5.3 billion to the DOJ to settle similar charges, and Barclays became the latest in a long list of lenders under investigation to be sued.
But the focus for financial markets was Italy where Monte dei Paschi said it would tap a 20 billion euro government fund approved late on Thursday.
A spokesman for Eurogroup President Jeroen Dijsselbloem said on Friday that there must be a bail-in of private bondholders first before Monte dei Paschi receives state aid.
The request from the world's oldest bank came after a private rescue was hampered by political turmoil caused by a referendum this month that led to the resignation of former Prime Minister Matteo Renzi.
With other Italian lenders looking fragile, the new administration of Paolo Gentiloni is looking to end a protracted banking crisis that has gummed up the economy.
"The situation in bond markets is reflecting the developments around Italian banks and investors are taking those well," Commerzbank strategist David Schnautz said.
Yields in other eurozone countries fell as the session wore on. The yield on Germany's 10-year bond, the region's benchmark, hit a three-week low of 0.22 percent by 1600 GMT, down 3 bps on the day.
Milan's stock market rose around 1 percent but trading in Monte dei Paschi's shares and bonds were suspended. Deutsche Bank's shares were up 0.6 percent by 1600 GMT.
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Other Italian banks that may struggle to raise capital in coming months are Banca Popolare Di Vicenza, Veneto Banca and Banca Carige.
Researchers at Barclays said state intervention is unlikely to represent a systemic solution for Italy's banks, estimating the largest six Italian lenders could need about 30 billion euros in total to clean up their balance sheets. (Editing by Nigel Stephenson and Susan Thomas)