* Public money cannot cover foreseeable or incurred losses
* The Veneto banks expect to book fresh loan writedowns
* Other banks may have to step in if private capital needed
MILAN, May 17 (Reuters) - Italian regional lenders Popolare di Vicenza and Veneto Banca may need to raise capital privately to cover loan losses to win European Union approval for a state bailout they have requested, six sources familiar with the matter said on Wednesday.
The two banks, together with fellow bailout candidate Monte dei Paschi di Siena, are stuck in rescue talks with European authorities that are keen to limit the amount of taxpayer money used to help ailing lenders in accordance with new EU rules on banking crises.
But having failed to raise funds on the market last year, the two Veneto-based banks may have no alternative to turning to healthier rivals for help once again, five of the sources said, in a fresh drag on Italy's weakened banking industry.
Both Popolare di Vicenza and the European Commission said negotiations were ongoing. Popolare di Vicenza, whose CEO Fabrizio Viola is leading talks with European authorities, said the bank would not comment on rumours and added discussions focused on targets set under a restructuring plan that envisages a merger between the two banks.
The two banks were rescued from bankruptcy a year ago by bank support fund Atlante, which took up 2.5 billion euros in initial share issues that were spurned by investors. It later pumped another 938 million euros into the two banks.
State-sponsored Atlante was financed by Italian banks and insurers, which have since been forced to write down the value of their stakes.
The two Veneto banks must fill a 6.4 billion euro capital shortfall after loan writedowns led to a combined 2016 loss of 3.4 billion euros and pushed their capital below minimum thresholds.
EU rules allow a state to step in to cover losses that a lender could potentially suffer under a shock scenario, but not losses that are foreseeable or have already been incurred.
The two banks have warned they are likely to book further loan losses this year as they apply guidelines provided by the European Central Bank, with a potentially significant impact on capital and earnings.
The sources said the prospect of fresh loan writedowns, which could not be covered with public money, was likely to force the two banks to raise capital privately first.
The rescue scheme under discussion entails a private contribution through the conversion of around 1 billion euros in junior debt into equity. The 938 million euros paid by Atlante should also count as private capital.
If more money from private investors is needed, there may be no alternative to other Italian banks chipping in to avoid failures that might destabilise the whole industry, five of the sources said.
In this case, banks would need to pay fresh funds into Italy's deposit-guarantee fund. To avoid breaching EU state aid rules, the fund has set up a separate, voluntary scheme which has already been used to rescue two small lenders in the past two years.
The fund's Director General Giuseppe Boccuzzi told Reuters on Wednesday that to date he was not aware of any such initiative.
$1 = 0.9007 euros Reporting by Stefano Bernabei, Paola Arosio, Valentina Za, Andrea Mandala, Writing by Valentina Za; Editing by Mark Potter