* Italian banking index rises, Intesa up more than 4 pct
* Taxpayers, not industry, to shoulder regional bank losses (Recasts with bank shares rallying)
MILAN, June 26 (Reuters) - Italian banking shares rallied on Monday after a deal to wind down two ailing regional lenders allowed Rome to draw a line under its biggest banking headache, with taxpayers rather than the financial industry shouldering the bulk of the losses.
Rome on Sunday approved an emergency decree that leaves the best assets of Banca Popolare di Vicenza and Veneto Banca in the hands of Intesa Sanpaolo, which is taking them on at the symbolic price of just one euro.
The government will pay 5.2 billion euros to Intesa, Italy's top retail bank, to ensure its capital ratios and dividend policy will not be affected by the deal, and give it guarantees of up 12 billion euros to shield it from any unexpected loss.
The total exposure for the state is for up to 17 billion euros, although the Italian treasury estimates the final bill will be much lower than that.
After drawn-out negotiations with Brussels, Italy won permission to liquidate the two banks under national insolvency procedures rather than have European regulators pull the plug on their own, potentially harsher, terms.
The Veneto deal comes after Rome was also allowed to bail out the country's fourth biggest bank, Monte dei Paschi di Siena for up to 6.6 billion euros, removing another systemic threat and helping restore confidence in Italy's fragile financial industry. To do that, however, the government has potentially used up the whole 20 billion euros it had set aside to help ailing banks.
"This is a major step in the direction of a cleaner Italian banking sector. Monte dei Paschi, Veneto and Vicenza were the three main concerns and they are now dealt with - one way or another," fund manager Axiom Alternative Investments said in a note.
Shares in Intesa, which is essentially cherry-picking the two banks' best parts for free and is expected by some analysts to start making money on them in 2018, were up 4.3 percent at 1028 GMT. The Italian bank index was up 3.5 percent.
On Monday, Intesa said it would close 600 branches and lay off 3,900 people as a result of the Veneto deal, but those restructuring costs are covered by public money.
The whole banking system breathed a sigh of relief, as a wind-down of the two Veneto banks under EU rules meant to stop state bailouts would have cost other Italian lenders 12.5 billion euros to guarantee deposits below 100,000 euros - spreading losses across an already battered sector.
The Monte dei Paschi and Veneto deals will take some 45 billion euros in bad loans off the banking sector's balance sheet. But even so, the Italian banking industry, Europe's fourth largest, remains saddled with some 300 billion euros of gross soured debts, the legacy of a deep recession and poor lending practices.
Banks are under pressure to sell those debts, but are reluctant to do so as they would have to book further writedowns that could force them to tap the market for cash. (Editing by Mark Potter)