MILAN/SIENA (Reuters) - Italian lender Monte dei Paschi di Siena (>> Banca Monte dei Paschi di Siena SpA) unveiled a plan on Friday to prevent its centuries-old business from being wound up by regulators, a privately funded overhaul that Rome hopes will help stabilise the country's entire banking sector.

Italy's third-largest bank, and the world's oldest, announced the plan moments before European banking regulators revealed the results of their stress tests which predicted that the lender's capital buffers would be entirely wiped out if there was a severe economic downturn.

Monte dei Paschi said it had secured underwriters to back its plan, which calls for the sale of 9.2 billion euros ($10.3 billion) in bad loans and a 5 billion-euro capital increase.

"The bank will have a new balance sheet," Chief Executive Fabrizio Viola said in announcing the blueprint, the latest in a series of turnarounds which have burned through 8 billion euros of capital raisings in the past 2-1/2 years.

This time, the euro zone's fourth-largest banking sector and Prime Minister Matteo Renzi are hoping for a genuine, long-term solution for the Tuscan lender, which has been struggling under a mountain of bad debts and accumulated losses.

Monte dei Paschi said it would sell the bad loans to a special-purpose vehicle to be backed by private investors, including a state-sponsored bailout fund, Atlante, which in turn is financed by dozens of financial institutions and a few state investors.

The vehicle would buy the bad loans at 33 percent of their face value, a relatively generous price for Monte dei Paschi, and then seek to recoup that investment by issuing bonds against them in an ambitious securitisation programme.

Bankers and analysts have said it will be tough for the bank to find enough investors to take up all those new bonds as well as tip 5 billion euros into the bank in the form of equity.

Crucially, the bank is counting on an existing EU-sanctioned state guarantee in order to sell a tranche of 6 billion euros of the new bonds at investment grade. Atlante would underwrite the sale of about 1.6 billion euros worth of the bank's riskier bad loans.

The worst of the bad loans would be given away to Monte dei Paschi's long-suffering shareholders, whose shares have lost nearly 80 percent of their value so far this year.

In addition, the bank said a group of Italian and international banks were willing to underwrite its 5 billion-euro capital raising, adding that it expected to complete both the cash call and the bad-debt sale by the end of the year.

Sources close to the matter said the European Central Bank has approved the plan in principle, but Monte dei Paschi said it still needed to present a more detailed proposal to the regulator.

The Italian government is keen to avoid having to inject public funds to recapitalise the bank. Under European rules, this would entail politically unpalatable losses for Monte dei Paschi's bondholders and depositors above 100,000 euros.

The bailout plan, drafted by advisers JP Morgan (>> JPMorgan Chase & Co.) and Italy's Mediobanca (>> Mediobanca Group), was approved by the Monte dei Paschi board after it rejected a rival recapitalisation proposal put forward by investment bank UBS (>> UBS Group AG), sources said.

So far six banks - Santander (>> Banco Santander, S.A.), Goldman Sachs (>> Goldman Sachs Group Inc), Citi (>> Citigroup Inc), Credit Suisse (>> Credit Suisse Group AG), Deutsche Bank (>> Deutsche Bank AG), Bank of America (>> Bank of America Corp) - in addition to the global coordinators JP Morgan and Mediobanca, have given a preliminary commitment to underwriting the planned share sale, the bank said.

The health of the lender poses a threat to the wider Italian banking system to the savings of thousands of retail investors and also to the increasingly weak political standing of Prime Minister Renzi.

Renzi faces a constitutional reform referendum in the autumn on which he has wagered his job. Monte dei Paschi is based in Renzi's home region and has some 5 billion euros of junior bonds, a large chunk of them held by ordinary Italians.

($1 = 0.8962 euros)

(Additional reporting by Valentina Za, writing by Silvia Aloisi; Editing by Mark Bendeich and Jonathan Oatis)

By Paola Arosio and Stefano Bernabei