The share sale will test investor confidence in Italian banks after the sector lost 40 percent this year, eroded by concerns over a 360 billion euro pile of problem loans and negative interest rates eroding revenues.

Italy's banking index closed down 4.4 percent on Thursday.

Popolare di Vicenza, which has been given until mid-May for the capital raising by the European Central Bank, needs the money to comply with the regulator's request to strengthen its capital and avoid the risk of being wound down.

UniCredit, which can ill afford to become a large shareholder in Popolare Vincenza, has committed to take on any unsold shares in the cash call for up to 1.5 billion euros.

"I am confident that the market reaction will be positive," Chief Executive Federico Ghizzoni told reporters. "This is a bank where you can get in at a price that is definitely competitive with an important upside potential."

Popolare Vicenza said on Thursday it had extended until May 10 the underwriting contract with UniCredit.

Ghizzoni declined to comment on whether UniCredit was seeking other lenders to share the risk of underwriting the issue.

UniCredit had considered delaying the deal after preliminary checks with investors in recent weeks "did not go too well", one source close to the matter said. [nL5N1725KT]

However, Italy's biggest bank by assets has decided to press ahead, and backing out of the contract could have had legal consequences, two sources told Reuters on Wednesday.[nL5N17952Z]

Popolare Vicenza will issue the new shares as part of a stock market listing. Marketing for the offer officially started on Thursday and is set to last about 10 days.

Taking orders from investors will follow with pricing expected towards the end of April, according to a document from one of the banks managing the issue.

At least half of the new shares on sale are reserved for institutional buyers, while 45 percent will be offered to current shareholders, mostly retail clients which are expected to see the value of their investment all but wiped out in the IPO.

Popolare Vicenza has so far lost 2.2 billion euros in a balance-sheet clean-up enforced by the ECB.

Meanwhile the bank is under investigation for allegedly deceiving regulators as the ECB uncovered 1.1 billion euros in loans Popolare Vicenza granted clients to help them buy its own shares.

The bank said on Thursday it would make sure any purchase of new shares by clients followed proper procedures and were not connected to any loans granted.

($1 = 0.8740 euros)

(Additional reporting by Luca Trogni, Editing by Keith Weir, Greg Mahlich and Susan Thomas)

By Valentina Za and Silvia Aloisi