UPDATE 1-Monte Paschi falls sharply as outlook sours for Italian banks
(Adds short-selling ban by Consob, analyst comments, context)
MILAN Aug 8 (Reuters) - Banca Monte dei Paschi led a retreat in Italian banking stocks on Friday in response to a bigger-than-expected loss and also due to the country's deteriorating economic outlook.
Shares in bailed-out Monte Paschi, Italy's No.3 bank, fell as much as 10 percent after its second quarter results, published on Thursday, revealed a big rise in charges for souring loans.
The sharp losses prompted Italy's market watchdog to ban short-selling of Monte Paschi shares until the end of the trading session on Aug. 11. The regulator had already imposed a short-selling ban on Banca Popolare dell'Emilia Romagna .
Shares in other Italian banks also fell, hit by the prospect that Italy's worsening economic prospects could force them to increase provisions for loan losses on their books.
Italy slid back into a recession for the third time since 2008 in the second quarter as the economy contracted by 0.2 percent, dashing hopes of an even mild recovery after nearly three years of economic crisis.
Traders said the unexpectedly bleak economic data prompted investors to cut their positions on Italian stocks, which had rallied since the start of the year.
Banks, proxy for Italy's economic performance, were hit particularly hard earlier this week.
Italy's return to recession in the second quarter "pushes back the improvement in loan volumes or asset quality that ... Italian banks were hoping for in the second half of 2014," Berenberg analysts said in a note.
Monte Paschi's results will mean the bank - which took 4.1 billion euros in state aid last year - will take longer to get back on its feet.
ICBPI analyst Luca Comi said the earnings confirmed that 2014 would be another year of balance sheet clean-up that will come on top of the impact of a weak economy.
Data released by the Bank of Italy on Friday showed bad loans at Italian banks rose by 20.9 percent in June on a year earlier, a lower growth rate than in May but still high. They now total 170.3 billion euros ($228 billion).
Shares in Monte Paschi were down 7.8 percent at 1.0550 euros by 0943 GMT. Banca Popolare di Milano fell 2.2 percent was down 1.7 percent and Credito Valtellinese lost 2.3 percent.
UBI Banca fell sharply at the open, but later turned positive as the broader Italian market bounced back and was up 3 percent after announcing an 81 percent rise in second-quarter net profit and stable loan loss provisions over the period.
Bucking the negative trend was also Banca Popolare dell'Emilia Romagna, helped by the short-selling ban imposed after its shares lost more than 10 percent on Thursday due to higher than expected charges on bad loans.
Italy's biggest banks Intesa Sanpalo and UniCredit , which released results earlier this month, have exceeded analysts' expectations and they have lowered their loan-loss provisions on an annual basis. (1 US dollar = 0.7468 euro) (Reporting by Lisa Jucca and Silvia Aloisi. Editing by Jane Merriman)