Up to eight of Italy’s troubled banks risk failing if prime minister Matteo Renzi loses a constitutional referendum next weekend and ensuing market turbulence deters investors from recapitalising them, officials and senior bankers say.

Mr Renzi, who says he will quit if he loses the referendum, had championed a market solution to solve the problems of Italy’s €4 trillion banking system and avoid a vote-losing “resolution” of Italian banks under new EU rules.

Resolution, a new regulatory mechanism, restructures and, if necessary, winds up a bank by imposing losses on both equity and debt investors, particularly controversial in Italy, where millions of individual investors have bought bank bonds.

The situation is being closely watched by financiers and policymakers across Europe and beyond, who worry that a mass failure of Italian banks could trigger panic across the eurozone banking system.

In the event of a “No” vote and Mr Renzi’s exit, bankers fear protracted uncertainty during the creation of a technocratic government. Lack of clarity over a new finance minister may lethally prolong market jitters about Italy’s banks. Italian lenders have more than halved in value this year on concerns about their non-performing loans.

Italy has eight banks known to be in various stages of distress: its third largest by assets, Monte dei Paschi di Siena, mid-sized banks Popolare di Vicenza, Veneto Banca and Carige, and four small banks rescued last year: Banca Etruria, CariChieti, Banca delle Marche, and CariFerrara.

Italy’s banks have €360 billion of problem loans versus €225 billion of equity on their books after successive regulators and governments failed to tackle a bloated financial system where profitability was weakened by a stagnant economy and exacerbated by fraudulent lending at several institutions.

But the market solutions, including a JPMorgan plan to recapitalise Monte Paschi and the efforts of a government-sponsored, private vehicle Atlante to backstop problems at smaller banks, are looking shaky in the face of expected market turbulence if a “No” vote wins, say officials and bankers.

Senior bankers and officials say the worst-case scenario is where a failure of Monte Paschi’s complex €5 billion recapitalisation and bad-debt restructuring demanded by regulators will translate into a wider failure of confidence in Italy and imperil a market solution for its ailing banks.

Under this scenario, officials and senior bankers believe that all eight banks could be put into resolution. They fear that contagion from the small banks could threaten a €13 billion capital increase at Unicredit, Italy’s largest bank by assets and its only globally significant financial institution, planned for early 2017.

- (Copyright The Financial Times Limited 2016)