By Francesco Canepa and Valentina Za

FRANKFURT (Reuters) -The European Central Bank has cleared Monte dei Paschi di Siena's proposed acquisition of rival Mediobanca, a source with knowledge of the matter told Reuters, as a raft of takeover bids reshape Italian finance.

Monte dei Paschi (MPS), which for a decade epitomised Rome's banking woes until a 2017 state bailout, in January shocked investors by bidding for the Milanese merchant bank that was once a powerhouse of Italian capitalism.

A spokesperson for the ECB declined to comment.

The takeover offer followed the state's sale in November of a stake in the bank to a group of Italian shareholders, including the Del Vecchio and Caltagirone families who are also leading shareholders in Mediobanca.

That sale is now being probed by prosecutors in Milan, sources told Reuters earlier this month.

MPS is worth 8.7 billion euros ($10 billion) at current prices, while Mediobanca market capitalisation approaches 16 billion euros - higher than the 14.6 billion euro value of MPS' all-share offer.

The decision was taken by the ECB's supervisory board via a written procedure. It is now set to be rubber stamped by the policymaking governing council of the ECB.

It will then be communicated to MPS which is expected to formally launch its offer in July and have it run over several weeks during which Mediobanca investors can tender their shares.

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MPS has billions of euros of cash in excess of regulatory capital thresholds, which it could use in part to top up the bid in cash once it starts.

Like other Italian banks, MPS has seen profits soar thanks to higher interest rates. It has also benefited from favourable court rulings that have allowed it to release cash it had set aside against legal risks.

In an effort to thwart the MPS bid, Mediobanca has proposed acquiring private bank Banca Generali to focus on wealth management.

However, that plan suffered a setback as Mediobanca was forced to push back to September a shareholder vote it had called on June 16 to approve the deal, as it risked lacking sufficient support.

Italy's conservative government had long said it wanted to use the reprivatization of MPS to foster the emergence of a larger rival to market leaders Intesa Sanpaolo and UniCredit.

Rome started selling down its 64% stake in November 2023.

After bringing onboard as MPS shareholders a dozen of international funds which bet on the bank's turnaround and its role in long-awaited Italian consolidation, Rome last November sold 15% of MPS to a group of domestic investors.

Alongside the Del Vecchio and Caltagirone families, that comprised Banco BPM and its fund manager Anima Holding.

Rome was looking to promote a tie-up between BPM and MPS, a plan derailed by UniCredit, which in late November bid for BPM.

However, UniCredit CEO Andrea Orcel said last week he would likely drop the BPM offer if the government sticks to conditions it has imposed to clear it.

($1 = 0.8645 euros)

(Reporting by Francesco Canepa and Valentina Za; Editing by Toby Chopra and Marguerita Choy)