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By Valentina Za, Pamela Barbaglia and Giuseppe Fonte
MILAN (Reuters) - UniCredit boss Andrea Orcel and Italy's government are poles apart over the terms of a deal to buy ailing bank Monte dei Paschi (MPS), people involved in the talks say, with the state balking at capital demands surpassing 7 billion euros ($8 billion).
Negotiations are expected to go down to the wire given that many issues remain unresolved but pressure has mounted to get to a conclusion.
Italy has long pointed to a merger with a healthier rival as the only way to draw a line under a decade-long crisis which has made MPS the epitome of the country's banking woes.
UniCredit, on the other hand, has few options at home if it wants to bridge a gap with rival heavyweight Intesa Sanpaolo, whose market share last year became twice that of UniCredit after the takeover of mid-sized peer UBI.
UniCredit would like to have a decision in hand by when its board meets to approve quarterly results on Oct. 27, but sources on both sides say that may now not happen, with a risk the three months' old talks could break down entirely.
In entering exclusive negotiations on July 29 to buy "selected parts" of MPS, UniCredit had stipulated the deal needed to leave its capital unaffected and boost earnings per share by 10%.
Italy's only bank of global systemic relevance said it targeted only MPS' branches in wealthier northern and central regions and would leave behind any soured or risky loans as well as legal risks stemming from mismanagement.
After concluding its due diligence analysis in September and leaving things to rest until after local elections earlier this month, UniCredit has only recently presented the Treasury with detailed demands and the ministry is still going through the documents, two of the sources said.
The main stumbling block is the cash Italian taxpayers will need to inject into MPS to return it into private hands only four years after spending 5.4 billion euros to rescue it.
MPS has plans to raise 2.5 billion euros in capital next year if it fails to find a buyer, but UniCredit believes even a capital raising twice that size would be only a stopgap solution, a person close to the matter told Reuters.
Rome disagrees with fair value adjustments UniCredit is requesting after applying its internal risk models to MPS' balance sheet, one source said. UniCredit declined to comment.
The source said the Treasury, which has already lined up tax breaks worth around 2 billion euros to ease the UniCredit-MPS deal, is reluctant to spend more than 3.5 billion euros to beef up MPS' capital reserves and fund staff exits.
To bring MPS' efficiency levels in line with its own, UniCredit needs to send 7,000 employees into early retirement, more than twice what MPS had planned to cut under a draft business plan through 2025.
The stakes are high for both parties were negotiations to fail.
The government of Prime Minister Mario Draghi faces a commitment to re-privatise MPS by mid-2022 at the latest, a lender which the European Banking Authority this summer identified as the most vulnerable in the euro zone in a stress test of the sector.
Orcel, the former investment banking chief at UBS, is hard pressed to boost UniCredit's revenues and profits after his predecessor focused on cleaning up the balance sheet and bolstering its capital reserves.
He has opened the door to potential mergers and acquisitions to accelerate growth but there are few domestic targets while cross-border deals remain a tall order.
Orcel has studied a possible move on Banco BPM, another mid-tier bank, two people familiar with the matter said.
He has put the dossier on hold to focus on MPS, which he has described as the best deal on the table for UniCredit.
In the meantime shares in Banco BPM have rallied 64%, against a 37% gain in Italy's banking index since the start of the year.
UniCredit's own shares, analyst say, have been lifted in part by expectations of a market-friendly deal with the Treasury, which in 2017 gave Intesa 3.5 billion euros in cash to convince it to buy for 1 euros the good assets of two local banks being liquidated.
(Reporting by Pamela Barbaglia in London, Valentina Za in Milan and Giuseppe Fonte in Rome; Additional reporting by Francesca Landini; editing by David Evans)