* Bank was founded more than 500 years ago
* Dominates life in and around Siena
* Trading losses could reach nearly $1 billion
By Silvia Aloisi
SIENA, Italy, Jan 25 (Reuters) - When the Monte dei Paschi di Siena bank was founded in 1472, Michelangelo was not born, Columbus had still to discover America and Henry VIII of England had yet to split from the church of Rome.
More than half a millennium later, the world's oldest bank is facing nearly $1 billion of trading losses in a scandal that has forced Italian authorities to issue reassurances about the stability of the Siena institution.
The bank's financial woes have raised the possibility that it could be nationalised, which would be one of the biggest upheavals since the marauding armies of the Duchy of Florence put an end to the Republic of Siena in 1555.
The politically charged affair follows hard on an investigation into Monte dei Paschi on suspicion that it manipulated markets and misled regulators when it bought its smaller rival Antonveneta from Spain's Santander in 2007.
The Siena bank, known as "Daddy Monte" because of its enormous influence and patronage, and its associated MPS foundation are as embedded in the psyche of the Sienese as the annual Palio horse race in which jockeys representing the city's historic quarters battle for supremacy on the sand-strewn main square of the Renaissance city.
The foundation is a politically powerful body meant to reinvest dividends in social and cultural projects. Its impressive art collection, housed in the city's Palazzo Salimbeni, spans six centuries.
Foundations like Monte dei Paschi's have stakes in all of Italy's leading banks but the MPS foundation is an anachronism even by Italian standards, clinging to power until it was forced to cede majority control last year in order to repay 1 billion euros of debts.
In good times, the bank's steady stream of dividends allowed the foundation to bankroll a myriad of projects in the city of Siena and the surrounding region -- strongholds of Italy's main centre left party, the PD.
With a month to go before a parliamentary election, it is those links to the PD that are coming increasingly under scrutiny.
The town hall and the province of Siena, both run by the PD, name 13 out of the 16 board members at the foundation, which in turns picks the majority of Monte Paschi's board representatives.
Between 1996 and 2010, the MPS foundation spent nearly 2 billion euros, more than half in the province of Siena alone, funding everything from a biotech facility to the building of roads to the training of horses for the Palio horse race.
In the meantime, the bank grew into Siena's largest private employer with 31,000 staff and six million customers.
An old adage says the city's 60,000 residents are divided into three categories: those who work for the Monte dei Paschi bank and foundation, those who are studying to work for it and those who are receiving pensions from MPS.
Critics have said that because their managers are handpicked by local authorities, the foundations only serve the interests of the politicians controlling them, a charge they deny.
"The foundations are an Italian scandal, they are the most powerful weapon in the hands of politicians to control the economy," Michele Boldrin, an Italian economist at Washington University in St Louis, once said.
"In the case of Monte dei Paschi, the city of Siena squandered its vast wealth just to keep a grip on the bank, so that politicians could keep their power," he said.
Indeed, keeping a tight grip on political power and patronage is something that critics say has guided Siena's rulers, from the princes of Machiavelli's times to the administrators of today.
But things began to go wrong in 2007, when Monte dei Paschi bought Antonveneta bank to expand its foothold in Italy's wealthy northeast, paying a whopping 9 billion euros in cash for it just months before the beginning of the financial crisis.
The acquisition catapulted the bank into Italy's big league -- making it the country's number three lender -- but it strained its finances to the limit. The bank is currently seeking a 3.9 billion euros ($5.2 billion) bailout from the Italian government.