The FTSE Italia All-Share Banks index fell as much as 1.5 per cent in early trading, before just managing to turn positive later in the morning, after Moody's said it had changed its outlook on the Italian banking sector to negative due to increasing capital needs and weakening confidence.
In a note last night, Moody's said recognition of losses will depress the sector's profitability and erode its capital over the next 12 to 18 months.
"Italian banks currently have one of the highest problem loan ratios in Europe at 16.4 per cent of total loans, more than three times the 5.4 per cent European average, as data from the European Banking Authority as of June 2016 showed," it said.
"Although problem loan formation in Italy has slowed considerably, a reduction in the outstanding amount will be gradual... This is because banks have limited resources in the form of excess capital over minimum requirements and private investors little appetite to finance the restructuring of Italian banks."
Shares in Monte dei Paschi, the Italian lender which is struggling to secure a €5bn rescue package, were down 1.3 per cent at €20.20 in mid-morning trading.
Unicredit, which last week sold its Polish banking arm in an effort to safeguard itself after last month's referendum on constitutional reform, fell 0.5 per cent to €2.80.
This morning figures showed consumer prices in Italy rose 0.1 per cent year-on-year in November - suggesting the country may be coming out of deflation.