As we noted over the weekend, Italy's bank stress test the result of which is due out on Friday, is a "near-term stress event", and one which Italy's most troubled bank, Monte dei Paschi di Siena, is expected to fail. It is Monte Paschi's massive non-performing debt load that is also the reason why over the past month Italy's Prime Minister Matteo Renzi has been desperately spinning Brexit as a catalyst event which would get Germany's blessing to enact a taxpayer-funded, public, bailout of not just the world's oldest, and Italy's third largest, bank but also of the entire Italian banking sector. Alas that has not panned out as expected, and Italy never got Germany's - or Dijsselbloem's - permission to launch another TARP.

Which explains why moments ago the FT reported that Italy was last night "racing to secure a privately backed bailout of Monte dei Paschi di Siena, the most exposed of the country’s troubled lenders, including a plan to raise €5 billion of fresh capital so as to avert nationalisation, according to bankers and European officials."

As a reminder, Monte Paschi has been bailed out by the state twice has raised over €8 billion of capital in the past two years, money which it quickly burned through, and as of this moment it has a market cap of just over €800 million. In other words, all else equal, the Sienna bank is looking at dilution of nearly 90%. Which would be a concern if the stock wasn't already trading as if it was insolvent, and if it hadn't been halted already over the past two days despite a recent short-selling ban which did absolutely nothing to the bank's long-term prospects.

In any event, with a public bailout of the picture, what's the Italian government to do ahead of a failed stress test (unless of course the ECB "passes" Monte Paschi and thus loses all credibility)? Resort to the only option it has - a private recapitalization.

According to the FT, "people directly involved in the Monte Paschi discussions say they are aiming for a private rescue of the bank to be announced before the stress test results are published after US markets close on Friday. "

But they admit that the negotiations could go down to the wire or run into or beyond the weekend. This raises the prospect of shares in Monte Paschi and other Italian banks coming under renewed pressure when markets reopen on Monday, which many fear could prove lethal. “If there isn’t a plan then investors will read the [stress test] results and on Monday kill the share,” said a person familiar with the thinking of the government of Matteo Renzi, Italy’s prime minister who has been working frantically to find a solution.

That, in turn, would unleash a bail-in and spark not only mass anger at the unpopular Renzi regime, but potentially also a bank run. The FT adds:

Mr Renzi, whose political future is tied to a constitutional referendum in the autumn, is desperate to avoid any hit to retail investors — and potential voters — which would come if the private solution fails and there is a state rescue instead. Any such rescue would be under EU rules, which would mean a so-called bail-in, where junior Monte Paschi bonds would be converted to shares, and compensation given to retail investors. Italian officials and senior bankers fears this would lead to a replay — on a larger scale — of the travails of Portugal’s Novo Banco, where the largest investors took the hit while retail bondholders were shielded, resulting in a collapse in investor sentiment and capital flight

What would a "private" bailout look like? "The privately backed plan, which is still under discussion and could change, would involve a multi-layered deal to rid Monte Paschi of €10bn of net non-performing loans and recapitalisation worth up to €5bn, say people involved in the talks."

The plan (or lack thereof) follows failed attempts by Renzi to find a “white knight” buyer for Monte Paschi, including Italy’s stronger capitalised banks, Intesa Sanpaolo and UBI Banca, say senior bankers.

But since a failure of Monte Paschi could likely unleash a countrywide panic, and lead to run on deposits across the entire sector, other banks may have no choice but to forcibly "chip in."

And yet, according to the FT, their contributions will still be negligible:

To clean up the lender, at least €10bn of its NPLs would be spun off into a special purpose vehicle. This would then be securitised, with shareholders taking the more risky junior tranche of debt and Atlante taking the mezzanine tranche.

This in turn goes back to a plan we detailed before, namely one involving a JPM-led securitization vehicle. "The least-risky senior tranche would be backed up to €7bn of bridge loans from a pool of banks likely to include JPMorgan of the US and Mediobanca, the Italian investment bank. The longer term aim would be for the senior tranche to be guaranteed by a government-backed scheme, known by the acronym GACS."

But even here, there is a problem, because to boost its capital, Monte Paschi would launch a rights issue of up to €5bn, its third in three years and worth more than five times its current market value.

Needless to say, "analysts believe this fund raising would be difficult given the bank’s reputation for scorching investors capital."

And then there is one final, and far bigger, problem: Monte Paschi is just the tip of the iceberg.

Analysts also said the problems in Italian banking would not be solved by the rescue of Monte Paschi. Carlo Tommaselli, analyst at Credit Suisse, has argued that Italy’s banking sector needs €30bn “to solve the NPL issue”.

Putting that in context, of the €360bn of loans which are unlikely to be repaid in full, €200bn are loans to creditors already deemed insolvent. Of those, €85bn are not already written down on banks’ books.

In other words, while largely under the radar, the fate of the Italian banking sector may depend on a very improbably bailout that has to be concluded in the next 48 hours: one which would involve a huge leap of faith by the private sector, and if unsuccessful, it could lead to the first major Bail In of a major bank on Italian soil, leading to further contagion, bank runs, and ultimately, a wholesale banking sector failure and bailout.

One thing we are certain of is that a bailout will come - sooner or later, and that as improbable as it may seem, Monte Paschi will get the funds it needs as the alternative would risk shaking up the entire European financial system which as we have covered since 2013 (ahem Deutsche Bank) is so frail, even a modest "fat tail" event could topple it. And just to be thorough, it is not only Germany's banks which stand to suffer. As we showed over the weekend, the one country most exposed to French banks the same one that in recent weeks has had far bigger problems of a terrorist nature: France.