Shares in Monte dei Paschi di Siena (MPS) fell sharply on Monday on reports that the European Central Bank (ECB) wants the troubled Italian lender to reduce its exposure to bad loans, piling the pressure on Italy's government to tackle its banking crisis.

The Siena-based bank confirmed receiving such a request from the eurozone's top financial authority, a fact originally reported by La Repubblica. The Italian newspaper presented the ECB's stance as an "ultimatum."

The ECB is asking MPS to reduce its gross non-performing loans from 43.4 billion euros (48.3 billion dollars) in 2016 to no more than 32.6 billion euros in 2018, the Italian lender said in a statement.

MPS insisted that the request for the 25-per-cent reduction was a "draft" still subject to negotiations ahead of a final decision by the ECB, due by the end of the month.

Markets reacted negatively to the report. MPS shares on the Milan stock exchange were down by more than 10 per cent, to little more than 34 euro cents, as of 2:40 pm (1240 GMT).

Impaired credit is a legacy of a 2008-2014 double-dip recession affecting all main Italian banks - not just MPS. Bad loans are a major drag because banks now have to hold back on offering new loans that could support Italy's timid economic recovery.

But MPS, founded in 1472 and considered the world's oldest operating bank, is in worst shape compared to other major Italian lenders.

The bank received state bailouts in 2009 and 2012 to counter bad management decisions and never fully recovered. It has seen its market value on the Milan bourse plummet by almost 80 per cent over the last 12 months.

MPS currently calculates it could recoup 39 per cent of the face value of its bad loans if it called them in. However, if it were to sell some of them to a third party in response to ECB demands, it would only get 20 cents to the euro for them, La Repubblica explained.

Accepting such a value writedown would create a 3-billion-euro gap on the bank's books, the newspaper said. That would force shareholders - including the Italian government which controls a 4-per-cent stake in MPS - to recapitalize it.

The concern is that private MPS bondholders could also be asked to suffer losses, in compliance with new European Union rules against taxpayer-funded bailouts. Italy has criticized those guidelines, arguing that they fuel investor panic and make bank runs more likely.

According to Monday's Financial Times, Prime Minister Matteo Renzi is considering ignoring EU constraints and taking "unilateral" action, including pouring public cash into a privately backed rescue fund that could help MPS and other lenders by buying their bad loans.

Government sources refuted the FT story, insisting that Renzi wanted to find "market solutions respecting applicable European rules."

In Brussels, European Commission spokesman Ricardo Cardoso said contacts with Rome were "ongoing" on "a number of solutions that can be in full compliance with EU rules [...] without adverse effects on retail investors."

Italy's government is under pressure to act before July 29, when the European Banking Authority is due to publish stress tests that may highlight the problems at MPS and other Italian lenders and increase market pressure against them.

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