LONDON European regulators expect Italian bank Monte dei Paschi di Siena will have to turn to the government for support, three euro zone officials with knowledge of the matter said, although Rome would strongly resist such a move if bondholders suffered losses.
Less than two months after the Tuscan lender announced an emergency plan to raise 5 billion euros (4.29 billion pounds) of fresh capital, having come last in a health check of 51 European banks, there is growing concern among European regulators that the cash bid will fall short.
While the bank is determined to see through the capital raising, if it were to disappoint, it would be left with a capital hole. Now euro zone authorities are considering whether state support would have to be tapped after what bankers have described as slack interest in the bank's share offer.
"There is clearly an execution risk to the capital raising," said one official with knowledge of the rescue attempt, adding that the bank's value, about one ninth the size of the planned 5 billion euro cash call, would be a turn-off for investors.
That person said a "precautionary recapitalisation by the Italian state" could be used to make up any shortfall once attempts to raise fresh cash from investors had concluded in the coming months.
Monte dei Paschi declined to comment. The Italian treasury did not want to comment for this story. A spokesman for Prime Minister Matteo Renzi said he was not aware of any expectations among European regulators that Monte dei Paschi may turn to the state for help.
Monte dei Paschi faces a considerable challenge in convincing investors to back its third recapitalisation in as many years. Further complicating the picture, a constitutional referendum, expected to be held by early December that could decide the future of Renzi, is likely to push the bank's fund-raising into next year, the officials say.
The bank's fragile state poses a threat to confidence in other Italian lenders and even to heavily-indebted Italy, the euro zone's third-largest economy.
Renzi and his economy minister, Pier Carlo Padoan, have said in recent days Monte dei Paschi's capital raising will be successful. Sources close to the consortium of banks that have made a preliminary commitment to underwrite the 5 billion euro privately-backed cash call dismissed suggestions it may fall short as "nonsense."
Reopening the question of state support, which had already been explored and dropped because of the losses it requires for bondholders under European bank crisis rules, is politically charged, and would reignite a dispute between Italy and Germany.
Berlin had objected to Rome's efforts to back the struggling bank without imposing a loss on its bondholders, according to another senior official.
But while some in the German government argue that Italian savers are wealthy enough to shoulder the bank's problems, Rome wants to spare both institutional investors and ordinary Italians who have tied up their money in its bonds at all costs.
Renzi's government fears that hitting bondholders would be extremely unpopular and could trigger a wider confidence crisis in the Italian banking system.
Those tensions were visible recently when Renzi took a public swipe at Germany, telling its central bank chief Jens Weidmann to fix the problems of its own banks which he said had "hundreds and hundreds and hundreds of billions of euros of derivatives".
As regulators, the European Central Bank, the European Banking Authority and the European Commission, are involved in the debate.
The European Union's executive has responsibility for enforcing rules to stop countries giving local companies an unfair advantage through state aid.
On Thursday, the Italian head of the European Banking Authority Andrea Enria told a newspaper, when asked about Monte dei Paschi, that, while he could not comment on individual banks, "if state aid could be part of the solution, let's use it."
While Enria has no direct say in the process, his comments chime with ECB President Mario Draghi's public backing in July for a state-sponsored backstop in helping Italian banks sell down some of their bad loans.
The ECB is influential as banking supervisor but whether any such step would be taken by Italy depends on the terms imposed by the European Commission.
A "precautionary recapitalization" of Monte dei Paschi would allow Rome to inject public funds, under certain conditions, without imposing steep losses on all of the bank's bondholders, as would normally be required by the EU.
The rules, however, are vague and there would still be room for argument on this point.
"It is certainly one of the options ... on the table," said one official familiar with thinking at the European Commission, referring to such state-backed recapitalisation. "Their (Italy's) preferred option is to find private investors."
That regime of recapitalisation, enshrined in European Union law, requires the bank to first convert some of its debt into shares, according to people familiar with the matter. The debt conversion is a step that Monte dei Paschi is considering as part of its own plan, although on a voluntary basis.
A spokeswoman for the European Commissioner in charge of state aid cases, Margrethe Vestager, said that it had "taken note" of the bank's "plans to launch a private capital raising exercise."
"This is fully in line with EU rules: any additional capital needs should in the first place be raised from the market and, or from other private sources."
(Additional reporting by Silvia Aloisi in Milan; editing by Anna Willard)