The world's oldest bank has indicated it will tap a €20bn Italian state rescue fund after its attempt to raise €5bn of fresh capital failed.

Banca Monte dei Paschi di Siena made the announcement after the government formally approved the aid package late on Thursday.

It is designed to prop up the country's ailing banking sector, which is drowning in €360bn of toxic loans that are dragging on the potential for economic recovery.

In the case of Monte dei Paschi, the government has agreed it can draw down cash from the fund under a formula agreed with the European Commission called "precautionary recapitalisation."

The bank was expected to be the first in line to request help after confirming speculation it had failed to find a big so-called cornerstone investor to underpin its attempt to sell new shares.


Image: More than 80% of the bank's market value has been lost

Italy's third biggest lender also scrapped a plan to swap bonds - parcels of debt held by investors - for its shares.

That effort had already raised €2bn but the bonds are now being returned.

The crisis at the troubled bank came to a head on Wednesday when it warned it could run out of money within four months unless its plans to raise new funds succeeded.

Its market value has plummeted by more than 85% since the start of the year - with shares closing 7.5% lower in volatile trading on Thursday. It was later confirmed there would be no dealing of its stock on Friday.

Image: The bank could be wound up by the ECB under Mario Draghi

Monte dei Paschi faced the prospect of being wound up without the state aid after the European Central Bank (ECB) refused to give the lender more time to raise the €5bn from investors two weeks ago.

The bank's apparent struggle to raise cash was exacerbated by the country's political crisis earlier this month.

Matteo Renzi's defeat in a constitutional referendum resulted in his resignation as prime minister.

Subsequent government talks over the possible bailout fund resulted in Monte dei Paschi deciding to continue under its own steam.

New PM Paolo Gentiloni's administration has also moved to reassure depositors their money is protected.

Image: Paolo Gentiloni is Italy's new PM

Italy's banking sector is labouring under the weight of €360bn (£300bn) in loans that are not being repaid as the economy struggles.

Their troubles hold back the economy further because they are the source of credit needed by businesses to operate and expand.

The country's biggest bank, Unicredit, used an event in London last week to announce 14,000 job cuts and raise billions from investors.

Any bailout at Monte dei Paschi will result in a hit to bondholders first under EU rules designed to spread the pain.