JPM JP Morgan Chase and Co

MILAN—Italy's Banca Monte dei Paschi di Siena SpA has presented to the European Central Bank a plan to shed about €10 billion ($11 billion) in nonperforming loans and raise up to €5 billion in fresh capital, in a bid to stave off a bailout by the Italian government and draw a line under its longstanding problems.

According to people familiar with the situation, Monte dei Paschi is seeking approval from the ECB to unload a large chunk of the bad loans to Atlante, a fund orchestrated by the Italian government and financed by Italian banks, insurers and pension funds.

Atlante would take on the worst-performing loans, while MPS would sell better-quality loans to private investment funds with the support of a government guarantee aimed at sweetening the transaction.

With a deal to unload the bad loans in place, Monte dei Paschi would then raise as much as €5 billion in fresh capital—or five times its current market capitalization—by the end of the year, the people said. Italy's Mediobanca SpA and J.P. Morgan would act as global coordinators for the capital increase.

The plan would avoid a government bailout which, according to European rules, would first require bondholders to sustain heavy losses—a scenario the government is keen to avoid given the large numbers of mom-and-pop investors who have bought the bank's bonds. Monte dei Paschi has €5 billion in outstanding junior bonds, with about half believed to be in the hands of Italian households.

An ECB spokeswoman declined to comment.

The bank is hoping for approval for its plan by Friday, when the European Banking Authority will publish the results of so-called stress tests of 51 European lenders. Monte dei Paschi is expected to emerge as the worst performer, a result that could further pummel shares that have lost 84% of their value in the past year and complicate any plan to rescue Italy's No. 3 bank.

Monte dei Paschi, which has nearly €50 billion in bad loans, has been of acute concern in an Italian banking system that has suffered from poor profitability and huge bad loans.

The bank has been bailed out twice by the government since the financial crisis and failed ECB stress tests in 2014. Efforts to bring it back to health have done little to revive Monte dei Paschi, which still has low profitability and thin capital buffers.

The government has hoped that a healthier bank would buy the lender, but no such offers have materialized. Some argue that a cleaned-up Monte dei Paschi could be more appetizing for a prospective buyer.

In trading in Milan, Monte dei Paschi's shares were up 3.5%.

Write to Deborah Ball at deborah.ball@wsj.com

(END) Dow Jones Newswires

July 27, 2016 07:25 ET (11:25 GMT)

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