By Francesca Landini and Lisa Jucca

CERNOBBIO, Italy (Reuters) - Italy and the European Commission have agreed that Banca Monte dei Paschi di Siena will have to carry out a larger-than-expected capital hike, cut costs and reduce its large government bond holdings in order to win a EU green light for state aid, officials said on Saturday.

Rome has offered 4.1 billion euros of state loans to Monte Paschi (BMPS.MI), Italy's No.3 bank, in order to prop the lender, which has a weak capital position following a derivatives scandal and big Italian bond investments.

European Competition Commissioner Joaquin Almunia and Economy Minister Fabrizio Saccomanni reached a broad political agreement on Monte Paschi at a meeting on the sidelines of a business gathering in Cernobbio, on the shores of Lake Como.

Almunia told a news conference he expected the EU's executive to formally give its green light to the state aid package for Monte Paschi over the next two months, once the tougher conditions are incorporated into the restructuring plan.

"We have reached a political agreement," Almunia said.

Siena-based Monte Paschi, which says it is the oldest bank in the world, had originally planned a capital increase of 1 billion euros.

That figure looks set to rise but Almunia declined to give the exact amount of the new, larger capital increase.

Sources familiar with the situation told Reuters in June that the bank's management was considering doubling the planned cap hike to 2 billion euros.

Contrary to other European countries, Italy has so far avoided a nationalisation of weak banks.

Almunia said Monte Paschi would carry out its capital increase in the 12 months following the approval of the amended turnaround programme.

"If the capital increase fails, the condition will be the conversion of state aid in bank shares," Almunia said.

Monte Paschi had 29 billion euros of government bonds at end June, one of the largest bond portfolios in Italy.

Rome has previously opposed suggestions the bonds would have to be sold immediately. But Almunia said on Saturday any bond sale would be gradual and that the bank will become viable once the new restructuring plan is implemented.

(Reporting by Francesca Landini, Editing by Lisa Jucca)