The Italian government approved a decree on Friday to bail out Monte dei Paschi di Siena after the world's oldest bank failed to win investor backing for a desperately needed capital increase.

Looking to end a protracted banking crisis that has gummed up the economy, Prime Minister Paolo Gentiloni said his cabinet had authorised a €20 billion ($29 billion) fund to help lenders in distress - first and foremost Monte dei Paschi.

Prime Minister Paolo Gentiloni said his Cabinet had authorised a $29bn fund to help lenders in distress. Credit:Alessia Pierdomenico

Within minutes of the late-night cabinet meeting ending, the country's third largest lender issued a statement saying it would formally request state aid, opening the way for possibly the biggest Italian bank nationalisation in decades.

The government has said its long-awaited salvage operation will work within European Union rules, meaning some Monte dei Paschi bondholders will be forced to accept losses to ensure the taxpayer does not pick up all of the bill.