Italy vote spreads fear of renewed crisis to European shares
* Banks lead sell-off after Italy vote stalemate
* FTSEurofirst 300 index falls 1.2 pct
* Euro STOXX 50 declines 2.7 pct, Italy market slumps 4 pct
* Traders see markets volatile on Italy uncertainty
* Euro STOXX Volatility index rises to fresh 2013 high
By Sudip Kar-Gupta
LONDON, Feb 26 (Reuters) - European shares slumped on Tuesday after elections in Italy threatened a renewal of the euro zone crisis, with bank stocks suffering most.
The pan-European FTSEurofirst 300 index fell 1.2 percent to 1,151.76 points while the euro zone's blue-chip Euro STOXX 50 index slid 2.7 percent to 2,581.25 points.
Italy's benchmark FTSE MIB equity index was amongst the worst hit, slumping 4 percent, reflecting concern that its election result, which left no clear government, could hamper economic reforms and fuel its costs of borrowing.
Worries about a new flare-up in the euro zone's debt crisis fed through to the bank sector, whose lenders could be hit with new writedowns and bad debts if the region's economy weakens as a result of debt problems in countries such as Italy and Spain.
The STOXX Europe 600 Banking Index was the worst-performing European equity sector, falling 2.4 percent as Italian banks such as Intesa and Unicredit slumped 7.5 and 7 percent, respectively.
"There's no clear outcome in the Italian election, and the markets hate uncertainty," said Terry Torrison, managing director at Monaco-based McLaren Securities.
"You could easily see a three or four percent sell-off in the next couple of sessions," he added.
The euro zone debt crisis led to a sovereign bail-out of Greece and other smaller countries, but Spain has also been under pressure over a possible similar bailout. Italy has faced a battle to contain its own borrowing costs.
Spanish Foreign Minister Jose Manuel Garcia-Margallo said the Italian result was extremely worrying. Spain's IBEX stock market falling 2.7 percent.
"Spain will also now come under pressure," said Syz Asset Management's chief economist Fabrizio Quirighetti, who added that European equity markets could potentially fall some 5 percent this week.
The fall on the Spanish and Italian stock markets was more pronounced than those of bigger, northern European markets seen as safer economies, with Germany's benchmark DAX equity outperforming bigger falls elsewhere with a 1.9 percent decline.
The Euro STOXX Volatility index surged 15 percent to reach a new 2013 high OF 24.73 points on Tuesday. The U.S. VIX volatility index jumped 34 percent on Monday, which marked its biggest rise since Aug. 18 2011.
BTIG European equity strategist Nick Xanders recommended investors to buy such volatility options to protect themselves from any free-fall on the stock markets, with the Euro STOXX Volatility Index still below its 2012 high of 38.31 points.
"Volatility is still not that expensive," wrote Xanders.