Barclays' 1 bln stg UK separation costs to hit 2016 profitability

* Barclays Q3 profit down 10 pct year on year

* Sets aside 290 mln stg to compensate FX customers

* Cuts 2016 RoE target to 11 pct due to higher costs

* Shares (Berlin: DI6.BE - news) fall 4.8 pct (Adds finance director, analyst, share price)

By Steve Slater and Matt Scuffham

LONDON, Oct (HKSE: 3366-OL.HK - news) 29 (Reuters) - Barclays (LSE: BARC.L - news) will spend 1 billion pounds ($1.5 billion) to shield its UK retail customers from riskier areas of the business, it said on Thursday, prompting it to increase its costs guidance for next year and cut its returns target.

The British bank also set aside 290 million pounds to compensate customers mis-sold foreign exchange products as it reported a 10 percent drop in quarterly profit.

Barclays shares fell 4.8 percent by 0914 GMT, the weakest stock in the European bank index.

Barclays detailed for the first time the expected costs associated with the so-called ring-fencing of its UK retail bank, required by law to be in place by 2019, and the setting up of a holding company for its U.S (Other OTC: UBGXF - news) . investment bank by mid-2016.

It (Other OTC: ITGL - news) will spend about 400 million pounds next year to implement those structural changes, having spent 100 million pounds this year.

As a result, guidance for core costs next year was raised to 14.9 billion pounds from 14.5 billion. It also cut the target for 2016 return on equity in its core business to 11 percent from 12 percent.

Barclays said it will spend about 500 million pounds more on its British ring-fencing in 2017 and 2018.

The bank, which announced this week that former JPMorgan investment bank boss Jes Staley will become its new chief executive in December, also warned that its investment bank had experienced weaker market conditions in October than a year earlier.

Conduct and litigation costs that have weighed on the bank in recent years continued as it set aside cash for the first time to compensate UK foreign exchange customers after an internal review of rates given on transactions between 2005 and 2012.

"We didn't apply the most appropriate foreign exchange rate and are looking to make that good," Finance Director Tushar Morzaria said.

"We believe the provision we've taken to be prudent and sufficient to work through all the issues that we've identified, but of course that work's ongoing," he added, declining to elaborate.

The bank also made a 270 million pound provision relating to settlement of litigation over U.S. mortgages that was announced this month.

CAPITAL CONCERN

Barclays reported adjusted pretax profit of 1.43 billion pounds for the three months to Sept. 30, down from 1.59 billion pounds a year ago and below the average 1.65 billion pounds forecast from analysts polled by the company.

Its common equity capital ratio, a core measure of a bank's financial strength, was 11.1 percent at the end of September, unchanged from three months earlier.

That was weaker than analysts expected and some said that it showed that the bank may have to seek a capital increase.

"There is a significant risk of a capital raise given the relatively weak capital position of the bank and the imminent stress tests," said Chirantan Barua, analyst at Bernstein, estimating it may need to raise 5 billion pounds.

Morzaria said he was pleased with capital generation over the past two years, given the provisions made for conduct and litigation issues, and said the bank was working towards getting its common equity ratio above 12 percent "as quickly and expeditiously as we can".

Its investment bank had a better quarter than most of its big U.S. and European rivals, with revenue up 9 percent from a year ago.

Revenue from fixed-income trading was down 2 percent and advisory and investment banking income rose 22 percent, both better than rivals. Equities income was up 12 percent, in line with U.S. banks. ($1 = 0.6554 pounds) (Editing by David Goodman)