MILAN/ROME (Reuters) - Italy has ruled out the idea of winding down two struggling lenders in the northern Veneto area, a source said on Sunday, following a report Brussels was set to tell Rome it could not use direct state support to rescue them.

FILE PHOTO: The logo of Veneto Banca bank is seen in Venice, Italy, January 31 2016. REUTERS/Alessandro Bianchi/File Photo

“The Treasury excludes any suggestion of a banking resolution,” a Treasury source said.

According to La Stampa daily the European Commission will tell Italy in coming days it cannot inject public money to rescue Veneto Banca [VBANC.UL] and rival Banca Popolare di Vicenza [BPVS.UL].

Citing sources at the Italian Treasury and EU institutions, the newspaper said Rome’s plan of using a precautionary recapitalisation to save the two lenders by using more than 5 billion euros (4.38 billion pounds) of public funds was no longer viable.

Instead the branches and assets of the two banks would be hived off into a “good” bank while the non-performing loans would be placed in a “bad” bank, it said.

A spokesman for the Commission said he could not confirm the report. “The Commission and the Italian authorities are working closely together to ensure a viable solution”.

Rome has been trying for months to reach an agreement over a bailout to avoid their liquidation.

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

But La Stampa said Rome had failed to find lenders willing to provide the private capital requested by the Commission.

It said talks with Italy’s main banks in recent days had spoken of a resolution - the EU procedure to wind down a failing lender - of the two Veneto lenders and their sale at a symbolic price.

Earlier this month European authorities stepped in to avert a collapse of Spain's Banco Popular following a run on the bank, orchestrating a last-minute rescue by Santander SAN.MC.

La Stampa said it was still not clear who might buy the performing assets of the two Veneto lenders but said talks were most advanced with Italy's Intesa Sanpaolo ISP.MI.

However it cautioned that Italy’s biggest retail bank was concerned about stretching its balance sheet and jeopardising dividends, adding that any acquisition might prompt the European Central Bank to ask for a capital increase.

The Italian Treasury and Intesa Sanpaolo were not immediately available for comment.

Italian Economy Minister Pier Carlo Padoan said on Friday he was confident a solution for the two banks could be reached soon.