By Danilo Masoni and Pamela Barbaglia
MILAN/LONDON (Reuters) - Italy's third biggest lender, Monte dei Paschi di Siena, said on Sunday it could plug a 2.1 billion euro (1.64 billion pounds) capital hole uncovered by a pan-European health check of lenders entirely through a capital increase.
The world's oldest surviving bank has hired UBS and Citigroup to assess strategic options after it failed the European Central Bank (ECB) tests, designed to gauge the solidity of the euro zone's financial system.
A capital increase would be the fourth rights issue for the Tuscan bank, which raised 5 billion euros in June to strengthen its balance sheet and help pay back state aid, since 2008 and it was not clear whether current shareholders would buy into it.
The bank said in a statement the capital plan also included possible asset sales, while it ruled out converting a state bailout it received in 2013 into shares - which would have meant partial nationalisation of the lender.
The bank, which must submit a capital-boosting plan to the European Central Bank by Nov. 10, also said it would not seek additional state aid.
It said its board would meet on Nov. 5 to approve the measures.
Two sources with knowledge to the situation had earlier said the bank planned to cover at least half of the capital shortfall with a cash call.
Banks that underwrote June's capital increase remained interested in backing the new rights issue, one of the sources said, adding the advisers were also sounding out potential new investors.
The plan under discussion also included an "M&A event" which was more difficult and there were various options on the table, this source said, mentioning UBI Banca as a possible candidate.
A spokesman for UBI said there were no talks whatsoever with Monte Paschi over a possible merger.
A third source close to the matter said "any merger plan would take a long time to come off."
The bank's chairman, Alessandro Profumo, told Reuters on Tuesday the lender could ultimately become part of a larger entity, though he said there had been no talks with any potential buyers.
Sunday's statement did not mention any plans for a tie-up. Profumo also said the bank might seek to delay repaying 750 million of euros in state aid to reduce its capital deficit.
Monte dei Paschi shares have dropped some 40 percent since the result of the ECB stress tests were announced a week ago, meaning the bank is currently worth less than half its value in early June when it raised 5 billion euros in new capital.
(Writing by Danilo Masoni, additional reporting by Silvia Aloisi, editing by Silvia Aloisi and Stephen Powell)