Eurozone Crisis

Italy's Unicredit bank has been forced to ringfence €48bn of toxic assets and has told staff 5,200 of them will be made redundant

Italy's largest bank, Unicredit, on Monday highlighted the obstacles faced by prime minister-designate Mario Monti when it sent out a plea to shareholders for extra funds to protect against bad loans to Greece and losses on subsidiaries in eastern Europe.

Unicredit, which operates in 22 European countries with more than 168,000 employees, said it needed to boost its reserves by €7.5bn after it plunged into loss, was forced to ring-fence €48bn of toxic assets, and told staff that 5,200 of them would be made redundant.

Details of the bank's poor state of health emerged as former EU commissioner Monti's struggle to form a new government took its toll on the country's borrowing costs.

Italian bond yields – which determine the interest rate paid on its debts – began to climb towards previous record highs that brought the country to the edge of bankruptcy last week.

Italy has the third largest bond market in the world after Japan and the US with debts of around 120% of national income.

The euphoria that accompanied Silvio Berlusconi's agreement last week to quit – and brought bond yields back towards the all-important 6% level – evaporated within hours of his departure on Saturday as it became obvious it would take time for Monti to win over rival factions to form a new coalition.

Bond yields reached 6.77% on Monday, raising concerns that international investors already considered a technocratic government under Monti a lame duck.

Europe's stock markets closed down as international investors raised questions about the prospect of Italy and Spain eventually going bust. Spain saw its borrowing costs rise to 6.13% on its 10 year bonds.

Spain and Italy's man indices both fell by 2%, while the French Cac and the German Dax lost 1% each. The FTSE 100 ended 26 points lower at 5519, a fall of almost 0.5%.

The chancellor, George Osborne, said a new administration in Rome should get to grips with its debts and "make their economies more competitive".

He urged the authorities in Brussels and Frankfurt to bolster the firewall needed to protect Italy and Spain to prevent a repeat of the financial collapse that forced Ireland, Portugal and Greece to need more than €300bn of bailout funds.

"The eurozone has the financial capacity to restore stability. They now need to deploy it without delay," he wrote in London's Evening Standard newspaper.

Meanwhile Angela Merkel, the German chancellor, warned that Europe faces perhaps its toughest time since the second world war in a speech to her Christian Democratic Union party. The German chancellor said that closer political union was needed to save Europe: "If the euro fails then Europe will fail," she cautioned.

The German finance minister, Wolfgang Schäuble, won a standing ovation at the Christian Democrat's party conference in Leipzig with calls to block all moves by the European Central Bank to buy more than token numbers of Italian bonds.

Schäuble told the conference that Europe must defend its currency, and acknowledged that Germany was "fairly alone" in believing that the European Central Bank must not be used for "unlimited financing of states".

Schäuble also argued that there was "too much liquidity in the world" – indicating that he remains opposed to the suggestion that the ECB should embark on a quantitative easing spree.

Details of a letter from Italian finance minister Guilo Tremonti to Olli Rehn, Europe's commissioner for economic and monetary affairs, also raised the prospect of social unrest.

Tremonti said he wanted to address the EU's concerns that Italy had failed to get its finances into line with a programme of tax rises and state asset sales, including the sale of unused prisons and military buildings. The letter also reveals that around 300,000 public sector jobs could be axed over the next three years.

The rise in Spanish bond yields will worry Brussels. Spain is due to seek several billion euros of loans in the next week and officials will want to restrict the rise in borrowing costs or risk a similar threat of bankruptcy that has plagued Italy.

Spain goes to the polls at the weekend to find a successor to the administration of José Luis Rodríguez Zapatero. The Spanish are expected to reject the socialists, who have been in power since 2004, in favour of the right wing Popular Party. Spanish politicians criticised the ECB for raising interest rates earlier this year, making it more costly for businesses to borrow and invest.

Osborne, like many EU finance ministers, has urged the ECB to cut rates and announce that it will protect all the economies in the 17 member currency club with unlimited funds.

Osborne, who said he stood alongside the US, the IMF and China in wanting further action from eurozone politicians, said an enhanced European Financial Stability Facility, which has €440bn pledged to it by eurozone members, could also play a vital role.

Osborne, who said he stood alongside the US, the IMF and China in wanting further action from eurozone politicians, said an enhanced European Financial Stability Facility, which has €440bn pledged to it by eurozone members, could also play a vital role.

"Whether it is done by the ECB or by eurozone governments is not the central issue: the financial risks of standing behind their currency will ultimately be borne by eurozone citizens," he said.