(Adds source on Monte Paschi resolution contingency plan)
By Paola Arosio
MILAN, July 26 (Reuters) - Banca Monte dei Paschi di Siena is working on a five billion euro (US$5.5 billion) capital increase as part of plans to fix its balance sheet ahead of European bank stress tests, a source said on Tuesday.
The bank, one of the few lenders in Italy to fail Europe’s last set of stress tests in 2014, is seeking to cobble together a banking consortium to guarantee the cash call, the source said.
“The hope is that at least a pre-consortium can be formed by Friday,” the source said.
The European Banking Authority is due to announce its health check on a group of European lenders from across the 28-country bloc on Friday.
Monte dei Paschi’s capital increase will follow a sale of 10 billion euros of its non-performing loans, the source said.
The Siena-based bank, which has already taken state aid, is in talks with Italian rescue fund Atlante over a deal to help it reduce its bad debts.
The lender, which has tapped investors for 15 billion euros of capital since 2008, has been told by ECB supervisors to cut its net bad loans by 40 percent in two-and-a-half years.
Europe’s oldest lender is waiting for the ECB to clear its plans for a share issue and bad loan clean-out, a second source said.
According to a third source, Monte dei Paschi’s capital increase plans do not envisage any state-backed guarantees.
Monte dei Paschi and the ECB both declined comment.
Saddled with 47 billion euros of non-performing loans, Monte dei Paschi is among the most exposed of a group of weak banks whose pile of bad debts and capital shortfalls are threatening contagion to other European Union nations.
The EBA tests will focus on 51 European banks, subjecting them to an adverse scenario that includes a protracted recession and a steep fall in commodity prices. The results are due to be released on Friday night.
On Tuesday a European Union official said EU authorities were making contingency plans for the possible winding down of Monte dei Paschi if it had a poor reading in stress tests and no private or public support was available.
Soured loans totalling 360 billion euros racked up by Italian banks after three years of recession have become the focus of investor concerns over the sector.
In an effort to reassure the market, Rome is looking for ways to support its lenders without breaking EU state aid rules that would require investors to take a hit first.
Earlier on Tuesday, government adviser Yoram Gutgeld said Italy was counting on the markets to help the Tuscan lender. ($1 = 0.9107 euros) (Reporting by Paola Arosio, Writing by Stephen Jewkes; Editing by Adrian Croft, Toni Reinhold)