The European Commission and Italy have reached a preliminary agreement on a state bailout for Monte dei Paschi di Siena that includes heavy cost cuts, losses for some investors and a cap on pay for the bank's top executives.
The deal brings close to an end months of negotiations over the fate of the world's oldest bank and Italy's fourth biggest lender, the worst performer in European stress tests last year.
The Commission said it had agreed in principle on a restructuring plan for the bank so that it can be bailed out by the state under new European rules for dealing with bank crises.
"It would allow Italy to inject capital into MPS as a precaution, in line with EU rules, whilst limiting the burden on Italian taxpayers," Competition Commissioner Margrethe Vestager said in a statement.
The bank would undergo deep restructuring to ensure its viability, including by cleaning its balance sheet of non-performing loans, she said.
Burdened by a bad loan pile and a mismanagement scandal, Monte dei Paschi has been for years at the forefront of Italy's slow-brewing banking crisis.
It was forced to request state aid in December to help cover a capital shortfall of €8.8 billion after it failed to raise money on the market.
The accord with the European Commission exploits an exception in current EU rules allowing member states to bolster the capital buffers of a bank provided it is solvent and that shareholders and junior bondholders shoulder some of the losses.
The government could end up injecting some €6.6 billion into the bank, taking a stake of around 70%.
The agreement with Brussels is conditional on the European Central Bank confirming the lender meets capital requirements and on the sale of some €26 billion in soured debts to private investors.
Monte dei Paschi said on Monday it was in exclusive talks until June 28 with a domestic fund and a group of investors to shift the debts off its balance sheet and sell them repackaged as securities.
Sources close to the matter said the price at which Monte dei Paschi sells those bad debts would be key for the bailout, as a low price would require the bank to book further loan losses which could not be covered by the state.
Details of Monte dei Paschi's restructuring plan have not been made public, but it is expected to include thousands of job cuts and the closure of hundreds of branches as the bank must ensure it is profitable in the long term.
"MPS will take a number of measures to substantially increase its efficiency," the Commission's statement said.
The EU deal also imposes a cap on senior management pay equivalent to 10 times the average salary of Monte dei Paschi's staff.
As a result, the annual salary of chief executive Marco Morelli should be cut to around €500,000 from more than €1.8m, according to a source.
The Commission said retail investors who were mis-sold the bank's junior bonds would be eligible for compensation.
Italy faces a much bigger hurdle in winning European approval for a state bailout of two other banks, Banca Popolare di Vicenza and Veneto Banca.
Sources have said the EU Commission has demanded an additional injection of €1.2 billion by private investors before taxpayer money can be used, but Rome is struggling to find any investor willing to stump up the money.