New European regulations demanding banks value government bonds according to their market price threaten a new credit crunch that could paralyse Italy's banks and economy, the head of its markets regulator was on Wednesday quoted as saying.

Consob head Giuseppe Vegas told la Repubblica daily that the European Banking Authority's (EBA) request that government bonds held by banks are marked to market were plainly questionable and that the regulator would seek to raise it at a European level.

He warned the domestic economy risked paralysis as banks shrank assets in an effort to boost their capital due to possible losses on sovereign holdings.

We are talking to the Bank of Italy to urge a reassessment also within the ESMA (European Securities and Markets Authority), Vegas said.

Vegas reiterated that, starting from Thursday, a ban on naked short-selling would be introduced for all categories of stocks in Italy.

He said a looming credit crunch threatened to choke the entire Italian economy.

In Italy there is a banking worry. Money is not circulating anymore. The main risk is a spreading of a credit crunch, Vegas said.

Under this scenario, the risk that one bank may fail is a secondary one. If the entire system's illiquidity paralyses the economy, then all of Italy, not just one operator, would fail, he added, calling for action.

Based on EBA's criteria, banks must boost their capital. They can either tap markets or sell assets, he said, adding that raising capital was more challenging than selling assets under present circumstances.

Vegas said Italian banks held 160 billion euros (136 billion pounds) of domestic government bonds. However, so-called toxic assets, mainly subprime mortgages, totalled only 6.8 percent of their regulatory capital, against a European average of 65.3 percent, he said.

With the new EBA rules we reach a paradox: government bond holdings are 'toxic' for Italian banks, worse than 'subprimes' are for some foreign banks, he said.

The Consob chairman also said there was a risk that the euro would break up if the European Central Bank was not allowed to start printing money in the same way as the Bank of England or the Federal Reserve.

(Reporting by Valentina Za; editing by Patrick Graham)