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* BoE's Cunliffe says investors should expect lower returns
* Profit expectations have not dropped to match reduced risk
* Banks need to cut costs or boost profit from investmentbanking (Adds detail from speech, context)
By David Milliken
LONDON, April 26 (Reuters) - Investors have not fully pricedin the likelihood that banks will generate lower returns than inthe past as they shift to less risky business models, a deputygovernor of the Bank of England said on Tuesday.
Major global banks such as Citi and Goldman Sachs have reported sharp falls in profits in their latestearnings, and some British ones such as Royal Bank of Scotland are in the midst of large-scale job cuts.
Jon Cunliffe, who is responsible for financial stability atthe BoE, said banks probably had more restructuring to do --especially in underperforming investment banking divisions --but that investors needed to lower their expectations too.
"There is clearly at present a wide gap between banks'disappointing returns on the one side and investors'expectations on the other," Cunliffe said in a speech in London.
Investors had the most pessimistic outlook on banks' abilityto increase the value of their assets since the 2011-12 eurozone crisis, he said, even though they were not so concernedabout banks' resilience as they were then.
Institutional investors who owned bank shares needed toaccept that the types of returns of around 15 percent a year onequity that banks achieved before the financial crisis were nolonger achievable, Cunliffe said.
Global interest rates had fallen, and regulators did notallow banks to take the same risks as before, he said.
Targets now stand at around 11.5 percent, but Cunliffe saidthis may still reflect "factors that are still inflatingrequired returns beyond the levels merited by risk".
One possible reason was that asset managers for institutionswith fixed liabilities -- such as pension funds -- were underpressure to continue to generate high returns even after a bigfall in interest rates.
Another was that some fund managers might also favour riskyshares because the upside to them of outperforming rival fundswas greater than the downside of underperforming, he added.
Regulators also needed to be clear that they were notseeking further significant tightening of capital requirements.
British banks' returns on retail lending stood at around 10percent a year, once the costs of past misconduct were takeninto account, while business lending generated returns of 8-9percent -- roughly in line with capital costs, Cunliffe said.
But their investment banking arms only generated 5 percent,suggesting parts were "not economically profitable" and in needof trimming.
"Banks' staff costs have not fallen anywhere near as much asshareholder returns," Cunliffe said.
(Reporting by David Milliken; editing by Ralph Boulton)
