By Silvia Aloisi and Stefano Bernabei

MILAN/ROME (Reuters) - Monte dei Paschi di Siena <BMPS.MI>, Italy's third-biggest lender, is set to approve a drastic restructuring plan on Tuesday aimed at winning the European Union's green light for a 4.1 billion euro (£3.45 billion) state bailout and averting nationalisation.

The world's oldest bank was brought close to financial collapse by the euro zone debt crisis and is engulfed in a judicial probe over its costly purchase of a rival in 2007 and loss-making derivative trades it made in the deal's aftermath.

Under pressure from Brussels, the bank must embark on a toughened-up turnaround plan that includes a 2.5 billion euro capital increase in 2014 - more than twice the amount originally pencilled by its managers.

EU Competition Commissioner Joaquin Almunia said this month that should Monte Paschi fail to raise the funds on the market, the government would have to convert into equity the state loans it gave to the bank in February, effectively taking it over.

The possibility that the Italian treasury could take a stake in the bank was already contemplated under the terms of the government's bailout scheme. This states that if Monte dei Paschi cannot pay its annual nine percent coupon on the state loans, it will issue shares to the treasury.

However the sheer size of the capital increase demanded by the EU, the third cash call for the bank since 2008 excluding the bailout, makes the prospect of Monte dei Paschi falling under direct government control a lot more likely.

The EU has also requested that the Siena-based lender, founded in 1472, shed more jobs and branches, cut the salaries of its top managers and gradually wind down its 29 billion euros Italian government bond portfolio.

Monte dei Paschi is already cutting 4,600 jobs and shutting 400 branches under a previous turnaround plan which the EU thought was too soft.

The new plan, to be approved by the bank's board on Tuesday, will be presented to investors before the market opens the following day.

In another sign that the lender is bowing to pressure from Brussels, it cancelled coupon payments on three hybrid loans coming due at the end of the month. Almunia had told the Italian government in July that bond holders should share some of the pain of the bank's rescue.

Monte dei Paschi has posted total net losses of nearly 8 billion euros in the past two years, and most analysts do not expect it to return to profit before 2015.

Without the bailout, its core Tier 1 ratio - a measure of a bank's financial strength - would fall to just 6.5 percent, well below a minimum of nine percent required by the European Banking Authority, analysts estimate.

The bank's judicial woes are also coming to a head. On Monday, the lender asked a London court to stay or dismiss legal action by Japan's Nomura <8604.T> over a risky 2009 derivative trade.

And on Thursday three of the bank's former top managers will stand trial in Siena on charges they hid from regulators the true nature of the trade with Nomura, which prosecutors allege was made to conceal losses.

(Editing by David Evans)