* Banks improved capital ratios by average 36 bps in Q3
* Dampens hopes for early dividend jump, now seen in 2015
* Banks fret over litigation costs, regulatory demands
* 12 pct common equity, 20 pct total capital could be norm
By Steve Slater
LONDON, Nov 21 (Reuters) - Shareholders' expectations for bank dividends have declined after lenders ramped up capital levels in the third quarter, spooked by a mega fine against JP Morgan and spiralling regulatory demands.
Major banks including Credit Suisse, UBS and Deutsche Bank either specifically set aside more for litigation costs or rebuilt capital at one of the fastest rates since the financial crisis in the last quarter, cutting the payout pool for yield-hungry investors.
Banks are keen to lift their dividends after cuts following the financial crisis, but a big jump in payouts may now be delayed until 2015 from a previously-hoped-for 2014.
"Banks have to maintain or strengthen their capital ratios. They want to pay dividends to shareholders and if they have to pay fines, something has to give," Alain Stangroome, head of group capital planning at HSBC, said at the Thomson Reuters IFR conference on bank capital on Thursday.
The prospect of a record $13 billion deal between JP Morgan and U.S. authorities to settle investigations into the sale of mortgage debt encouraged European rivals to set aside more cash to cover misconduct risk. The settlement, the largest levied on a single firm, was confirmed this week.
"The (conduct and litigation cost) numbers have lost the capacity to shock and we've seen an arms race in terms of the numbers involved," said John-Paul Crutchley, analyst at UBS.
As well as larger fines for misconduct, regulators in Switzerland, Britain, Sweden and elsewhere are ratcheting up capital requirements to avert a replay of the financial crisis.
The regulatory squeeze saw banks get their balance sheets into better shape in the July-September period and that trend is expected to continue in the fourth quarter.
Europe's banks raised their core Tier 1 capital ratios, the central measure of a bank's financial strength, by 36 basis points (bps) on average in the third quarter, lifting their increase in the past year to 105 bps, said analysts at Barclays.
Credit Suisse's core capital jumped by 100 basis bps in the latest quarter, while rival UBS increased its ratio by 70 bps and there were increases of 60 bps at HSBC and 46 bps at Spain's Santander.
Nordic banks, already better capitalised than most European rivals, extended that gap as core capital ratios at SEB and Handelsbanken rose by 100 bps or more.
The way banks report can vary but capital levels have broadly doubled since the 2007/08 crisis, helped by emergency cashcalls and cuts to dividends.
"NEW GOLD STANDARD"
Some regulators have signalled they may move further to "gold-plate" national capital standards, meaning that investors will generally expect banks to hold common equity of 12 percent of their risk-weighted assets, compared to 7 percent under incoming global rules, and a total capital ratio of 20 percent.
"Twelve and 20 ... that seems to be becoming the new gold standard," said Simon McGeary, MD of new products at Citi.
Royal Bank of Scotland bumped up its target for core capital to 12 percent from 10 percent earlier this month.
Switzerland's finance minister said banks there could need a leverage ratio of 6-10 percent, more than double the global standard, and UBS was hit with a temporary top-up of capital it holds for potential legal and compliance costs.
Britain is finalising plans that look set to ramp up capital demands, Stockholm is also increasing pressure on its banks and an upcoming review of the quality of assets across eurozone banks are further reasons for a conservative approach.
"The unpredictability quotient on regulation has risen... which makes it difficult for banks to have as much confidence as they'd like that they won't fall foul of regulatory change at a later date," said Mike Harrison, analyst at Barclays.
Many banks are still expected to raise their dividends - including HSBC, BNP Paribas, UBS and Nordea - but investors may need to wait until 2015 for big increases.
Analysts at Credit Suisse have forecast UBS's dividend yield will rise to 3.8 percent in 2015 from 1.2 percent in 2013.
Yields at Nordea should nudge to 7.7 percent in 2015 from 6.1 percent this year, HSBC's should rise to 6.8 percent from 5.5 percent and SocGen to 5.9 percent from 2.1 percent over the same period, according to the Credit Suisse forecast.
U.S. rivals have also been keen on raising dividends and buying back more stock, but their distribution plans have been under strict scrutiny from the Federal Reserve. The regulator can approve or reject plans and a handful - including Citi and Bank of America - have had plans rejected.
For Spain's banks, the balance sheet scrutiny and the prospect of stricter definitions of capital adds to the need for them to cut payouts, analysts said.
Payouts to Spanish retail shareholders, who are also typically customers, is important to many banks, but Santander - which paid out more than 200 percent of its profits in dividend last year - is expected to follow BBVA, which has cut this year's dividend and capped next year's payouts.