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UPDATE 3-Italy suspends Veneto Banca bond repayment as rescue bid stalls

(Adds government decree suspending bond repayment)

ROME, June 16 (Reuters) - Italy on Friday approved an emergency decree that will stop Veneto Banca from having to repay 86 million euros of subordinated bonds due to mature next week.

The suspension gives the government more time to try to reach an agreement over a bailout of Veneto Banca and rival Banca Popolare di Vicenza, which together need 6.4 billion euros ($7.17 billion) in new capital while they try to offload bad debts.

Italy is racing to win European Union approval for the rescue of the two troubled banks, based in the wealthy northeastern Italian Veneto region.

Talks between the government and the European Commission have dragged on for months because Brussels wants private investors to pump 1.25 billion euros into the two banks before any taxpayer money can be used to avert them being wound down.

In an unprecedented move, the government decided to suspend the payment of the junior bonds coming due on June 21 to fend off potential legal challenges against the bank, according to a statement after a late-night cabinet meeting.

It said the bond repayment would now be delayed for six months from when the bank requested state aid, which means the bond will not have to be repaid until mid-September.

The suspension aims to ensure all investors in the bank's junior debt will be treated equally in case of a state bailout, the government said. Under EU rules for dealing with troubled banks, losses have to be imposed on subordinated or junior bond holders.

Legal experts had said that if Veneto Banca had decided to honor the bond repayment next week, it could have angered other bondholders who risk large losses under EU rules for bank bailouts. But if the bank had not repaid back the bond, it could have triggered a default.

A source close to the situation said earlier on Friday that scenario could be avoided if the government suspended the repayment, though it was unclear whether that would be enough to stop possible legal challenges.

Italian Economy Minister Pier Carlo Padoan, speaking before the emergency cabinet meeting in Rome had approved the bond repayment suspension, expressed confidence that a solution for the two banks could soon be reached.

But a second source familiar with the situation said there was no guarantee an accord could be reached over the next week.

Rome has put pressure on other Italian banks to step in but with little success so far. With both Veneto lenders bleeding deposits, a European Union official warned last month that they may be wound down if no deal is reached by the end of June. In these circumstances, the Veneto Banca's subordinated bond June 21 repayment created yet another headache for the bank and the government.

"Having to make a decision on the bond while the bank is in such a critical situation, you risk violating the principle of treating creditors equally if the bond is repaid, or of not meeting an obligation if it isn't," Craig Byrne, Partner International Capital Markets at law firm Allen & Overy, said.

Besides the risk of lawsuits from other bondholders in the even of a repayment, the bank's board members could also have been held responsible for authorizing the repayment.

"The situation is very delicate, the subordinated bond is one of the thorniest issues at the moment," a third source close to the matter said. ($1 = 0.8931 euros) (Additional by Valentina Za and Andrea Mandala in Milan and Francesco Guarascio in Luxembourg,; editing by David Clarke and Jane Merriman)