By Stefano Bernabei and Giuseppe Fonte
ROME (Reuters) - Italy is preparing to take a 2 billion euros controlling stake in Monte dei Paschi di Siena <BMPS.MI> as the bank's hopes of a private funding rescue fade following Prime Minister Matteo Renzi's decision to quit, two sources close to the matter said on Tuesday.
The government is already the ailing bank's single largest shareholder with a four percent share, but is planning to buy junior bonds held by ordinary Italians to take the stake up to 40 percent, the sources said.
This would make it by far the biggest shareholder, meaning the Treasury would be able to control Italy's third biggest bank and its shareholder meetings.
The sources said a government decree authorizing the deal, which would see the state buy the subordinated bonds from retail investors and convert them into shares, could be rushed through as early as this weekend.
Monte dei Paschi must raise 5 billion euros ($5.4 billion) by the end of this month to avoid being wound down, but private investors are reluctant to provide cash after Renzi lost a referendum on Sunday and announced plans to resign.
The bank is set to raise 1 billion euros from a bond swap with institutional investors and Rome is hoping the 2 billion euros participation from the government could help persuade private investors to fill the 2 billion euros gap.
"It's a de-facto nationalization with a strong presence by the state that can attract other investors and allow the transaction to be completed," said one of the sources, speaking on condition of anonymity.
The Treasury and Monte dei Paschi declined to comment.
Renzi is expected to leave office in days and could be replaced by his economy minister or another leading politician. But an early election might be held next year, raising investor fears that a maverick, anti-euro party could take power.
Italy's treasury would buy the bonds held by around 40,000 retail investors at face value, the sources said.
That way, the government would ensure retail investors do not suffer any losses in the bank's bailout, making it politically more palatable and staving off the risk of a run on deposits that could trigger a wider banking crisis.
The European Commission would need to assess whether the government's intervention is taking place at market prices or if it constitutes state aid, another source said.
Monte dei Paschi, rated the weakest lender in European stress tests this summer, had planned to arrange a private rescue, starting with a firm commitment from one or more anchor investors and then launching a share sale this week.
However, investment banks lined up to underwrite that plan, led by JPMorgan <JPM.N> and Mediobanca <MDBI.MI>, have in effect put the deal on hold due to political uncertainty.
One source said they would make a decision by Friday but that the chances of the privately backed deal going ahead as planned were now slim.
A source close to Qatar's cash-rich sovereign wealth fund said it could inject 1.4 billion euros in the bank but wanted to wait to see what kind of government would succeed Renzi. Other sources were more cautious on Qatar's willingness to back the deal.
Italy's head of state on Monday asked Renzi to put his resignation on hold until the 2017 budget is approved by parliament, which is expected to happen on Wednesday.
The bank's chief executive, Marco Morelli, held talks with European Central Bank officials in Frankfurt on Tuesday to review its options. A meeting of the bank's board is likely to take place on Wednesday.
(1 euro = $1.0700)
(additional reporting by Paola Arosio in Milan and Tom Finnes in Doha, writing by Silvia Aloisi; editing by Anna Willard)