The Italian government has approved a bailout of Monte dei Paschi di Siena at a late night cabinet meeting in Rome, led by prime minister Paolo Gentiloni.

The state rescue of the country’s third largest bank, saddled by non-performing loans, became necessary after it failed to raise enough capital in the wake of European-wide stress tests published in July.

A last-ditch effort to gather funds in the last few days only yielded about €2.5bn, well short of the €5bn target required.

In the decree approved early on Friday, the Italian government also announced a compensation scheme for retail investors in junior debt who would be hit under EU rules on burden sharing, saying that they would be able to receive senior debt of the equivalent value in exchange for the subordinated bonds.

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