Last checked at 
* Q3 pretax profit 1.3 bln stg vs forecast of 1.1 bln
* Bank won't pay dividend until capital position improves
* 154 branches to shut this year, of which 102 alreadyclosed
* Plans to retain Ulster Bank as core part of business
* Shares up 4 pct, hit highest in 12 months (Adds details on branch closures, investment bank)
By Matt Scuffham
LONDON, Oct 31 (Reuters) - State-backed Royal Bank ofScotland has set aside 400 million pounds ($640 million)to cover potential fines for manipulating currency markets andwarned further charges for past misconduct would continue to hitits profits.
RBS, 80 percent-owned by the British government following a45 billion pound bailout during the financial crisis of 2007 to2009, on Friday joined other big rivals in signalling it isclose to agreeing settlements over alleged manipulation of the$5.3 trillion-a-day foreign exchange market.
Rival Barclays said on Thursday it had set aside500 million pounds to cover potential FX fines, while JP Morgan, UBS and Citi have also set aside largesums.
The forex manipulation, revealed after banks were alreadyunder scrutiny for profiteering in the setting of benchmarklending rates such as Libor, relates to daily fixing rates whichtraders are alleged to have manipulated to suit their own marketpositions.
RBS also faces a number of other probes relating to pastmisdeeds which threaten to undermine its turnaround under ChiefExecutive Ross McEwan, who has steered the bank back into profitthis year after it made a loss of 8.2 billion pounds in 2013.
"We are actively managing down a slate of significant legacyissues. This includes significant conduct and litigation issuesthat will continue to hit our profits in the quarters ahead,"McEwan told reporters on Friday.
RBS is being investigated by regulators looking into itsselling of bonds backed by residential mortgages in the UnitedStates and its treatment of struggling small British firms. Thebank is also expected to be fined by British financialregulators for an IT failure two years ago which left customerswithout access to their bank accounts.
In addition, RBS faces a mounting bill to compensatecustomers mis-sold loan insurance. It set aside another 100million pounds to deal with the matter on Friday, taking itstotal bill to 3.3 billion pounds.
GROUP SETTLEMENT
RBS is one of six banks in talks with UK regulators on adeal that would involve them paying about 1.5 billion pounds ina group settlement in relation to alleged forex manipulation,sources have said. They said a deal could come in mid-Novemberand U.S. regulators were also working on a group settlement.
McEwan said RBS would not pay a dividend until it has moreclarity over future misconduct charges and has substantiallystrengthened its capital position, potentially making it moredifficult for the government to start selling its shares.
"I don't think we should be thinking about dividends untilwe've got a really good capital build and seen some of the bumpsin the road out of the way," he said.
RBS increased its core Tier 1 capital ratio by 70 basispoints to 10.8 percent during the third quarter and its leverageratio improved by 20 basis points to 3.9 percent. The bank hasset a target of holding core Tier 1 capital of more than 12percent by the end of 2016.
"There's no way we will be paying a dividend until we getourselves well in advance of that 12 percent target," McEwansaid.
Britain's financial regulator expects banks to hold anabsolute minimum of 7 percent core capital. However, investorsgenerally expect a ratio of at least 10 percent.
The Bank of England is expected to impose a tougher leverageratio than the current 3 percent requirement on UK banks lateron Friday. It is expected to require banks to hold between 4 and5 percent, meaning they can lend between 20 and 25 pounds foreach pound of capital held in reserve.
RBS said it made a third-quarter pretax profit of 1.3billion pounds, compared with a loss of 634 million the yearbefore. That was ahead of an average analyst forecast of 1.1billion compiled by the bank.
An economic revival in Britain and Ireland has enabled RBSto recover debts it had written off. The bank had a net releaseof previously written-off loans of 801 million pounds during thequarter, ahead of an average forecast of 590 million.
RBS's corporate and institutional banking arm slumped to aloss of 557 million pounds, compared with an 18 million loss ayear ago. That reflected charges of 562 million pounds formisconduct, including 400 million for forex fines.
The division, which is being shrunk and focusing on lessrisky areas, also had significantly lower income, RBS said.
Shares in RBS, which have risen by more than a quarter inthe past six months, were up 4.3 percent at 1145 GMT. They roseas high as 381.6 pence, their highest in 12 months.
"The build in capital is strong notwithstanding substantialconduct and restructuring provisions," said Deutsche Bankanalyst Jason Napier.
RBS said it had decided to keep Ulster Bank, having carriedout a review of the business which could have resulted in itbeing sold off. McEwan said the unit could deliver attractiveshareholders returns in future.
Like other British banks, RBS is closing branches inresponse to customers choosing to bank online instead. It hasseen a 30 percent drop in branch transactions since 2010.
McEwan said RBS had already closed 102 branches this yearand expects 154 to have shut by the end of 2014, the equivalentof 5 percent of its network.
(1 US dollar = 0.6263 British pound) (Editing by David Holmes and Pravin Char)
