The European Commission told Italian lender Monte dei Paschi di Siena to beef up a restructuring plan before it can be given approval for a 4 billion euro ($5.3 billion) state bailout.
Competition Commissioner Joaquin Almunia said in a letter sent to the Italian government on July 16 the plan by the scandal-hit bank was too soft on executive pay, cost-cutting, provisioning policies and treatment of creditors.
Almunia also called for a reduction in the bank's trading activities and exposure to sovereign risk.
Monte dei Paschi, Italy's third biggest lender, received a state bailout earlier this year to plug a capital shortfall but the EU still has the right to reject the plan, opening up the possibility it might have to repay the cash.
"I am foremost concerned with the viability of the bank. In order to allow the bank to restore its viability the existing restructuring plan needs still to be improved," Almunia said in the letter, obtained by Reuters.
A spokesman for the Italian treasury said the Commission had not rejected the plan and that negotiations were continuing.
In a sign that no quick agreement is expected, he said the process would take "months, not weeks".
The EU Commission said it would not comment on leaks.
No comment was immediately available from the 500-year-old bank, which is at the centre of a judicial probe over loss-making derivatives deals carried out by its former management.
In his letter, Almunia told Italian Economy Minister Fabrizio Saccomanni that without urgent changes he would launch a full-blown EU probe, a procedure that can last a couple of years and could lead to the state aid being ruled illegal.
News of the letter weighed on the bank's shares, which fell 2.5 percent to 0.21 euros by 1328 GMT.
"The news is negative because a negative opinion from the European Union risks slowing down the recovery of the bank," said ICBPI analyst Marco Sallustio in a note, adding he expected Monte dei Paschi to modify its restructuring plan when it announces first-half results on Aug. 7.
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The bank has already announced 4,600 job cuts, the closure of 400 branches and a 1 billion euro capital increase to be launched next year as it tries to rebuild its finances.
Chairman Alessandro Profumo and CEO Fabrizio Viola have refused to say what additional measures were included in the restructuring plan they sent to Brussels last month, although sources have told Reuters the size of the capital increase could be doubled to 2 billion euros.
In his letter Almunia disputed as exaggerated an estimate from Saccomanni that 5,000 jobs would have to be cut to make up for lost revenues of 320 million euros if the bank were forced to axe its proprietary trading operations and gradually write down its sovereign exposure.
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Another point of concern was the proposed continuation of coupon payments to certain bondholders, with the EU saying cash outflows from the bank to them should be "prevented to the maximum extent legally possible".
This could affect the bank's top investor, a charitable foundation with close links to local politicians which already has had to write down the value of its stake in the bank by 4 billion euros over the past two years.
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