UPDATE 2-Income drop clouds Santander's profit surge
* 9mo net interest income 19.7 bln euros vs f'cast 19.9 bln
* Net profit up 77 pct at 3.3 bln eur
* Lower provisions against bad debts help lift profit
* Net interest income falls as Brazil, Spain weigh
* Sabadell, Bankinter report similar trends (Rewrites first paragraph, adds analysts quotes, details on Brazil, Spain, share price)
By Sarah White
MADRID, Oct 24 (Reuters) - Falls in net lending income at Santander, the euro zone's biggest bank, and two smaller peers have highlighted the struggles banks still face ahead of a Europe-wide review of their assets and prospects for months of slow growth in Spain.
Santander, which has relied on Latin America to offset its Spanish woes after an economic slump and a property market crash, missed analysts' revenue forecasts, as a fall in lending and low interest rates knocked income from loans.
Net interest income of 19.7 billion euros was 14 percent lower than a year ago and below analysts forecasts of 19.9 billion. It was also down 10 percent at Bankinter and 4.6 percent at Sabadell.
A shaky economy in Brazil, where Santander makes a quarter of its income, also took its toll, while results from smaller peers Sabadell and Bankinter on Thursday echoed the pressure the lender faces in its home market.
In Brazil, Santander's quarterly net profit shrank nearly 33 percent to 358 million euros against the third quarter of 2012 and it also shrank compared with the April-June period this year, even as provisions for bad debts fell.
However Santander said on Thursday it was in a very comfortable position to comply with stricter Basel III rules being phased in as of next year and which will be used by the European Central Bank (ECB) as a reference to review asset quality at more than 100 banks across Europe.
Unfavourable exchange rates were in part behind the falls in Santander's net interest income, a closely-watched measure of earnings on loans minus deposit costs, but it also shrank in Brazil.
"Concern will focus particularly on weak Latin America, not all explained by foreign exchange moves, which we expect people would have been looking to drive profitability recovery," analyst Benjie Creelan-Sandford at banking group Macquarie said in a note.
Shares in Santander, whose net profit jumped as it put less cash aside to cover losses in Spain, pared initial losses and were up 0.4 pence at 6.57 euros by 0830 GMT, in line with euro zone bank shares which were up 0.4 percent.
Santander's shares have risen 31 percent in the last three months as the sector as a whole benefits from prospects for Spain's economy to start to recover from its lengthy recession.
Its nine-month net profit rose 77 percent to 3.3 billion euros, in line with forecasts. Nine-month profit in other key markets such as Britain, where the bank is refocusing on company clients, fell, but improved on a quarterly basis.
Shares in Sabadell, which beat analysts' expectations with a 186 million euro nine-month net profit, were up 5 percent to 1.8 euros. Bankinter also beat forecasts with a 156 million euro nine-month profit and its shares were up 2.3 percent at 4.4 euros.
Spanish banks' earnings have been flattered this year by lower provisions against losses on soured loans, after they were forced by the government in 2012 to put aside cash to counter rotten real estate deals after a five-year-old property crash.
Spain turned to Europe for funds to recapitalise its weakest banks, which did not include Santander, Sabadell and Bankinter. As the ECB gears up for a Europe-wide stress test next year, many analysts believe some Spanish lenders may need more cash over the next 12 months.
Santander ruled out any capital increase but said it would not exclude action in some geographies or segments when needed to meet a target capital ratio of above 9 percent under stricter "fully-loaded" Basel III criteria.
While Bankinter said it had a core capital of 11.4 percent at the end of the third quarter under this criteria, Sabadell, which last month turned to investors for a 1.4 billion euro capital hike, did not disclose what its ratio would be.
Spanish banks are lobbying the government to turn up to 30 billion euros of deferred tax assets into state-backed tax credits to boost their capital under new international rules.
Analysts believe it will be a key element in determining whether they will pass or fail the tests.
Despite its big overseas push, Santander has also bet strongly on an economic recovery in Spain and recently bought half of the country's biggest consumer finance business from department store El Corte Ingles.
But households and small companies are still struggling and credit is shrinking, pushing up banks' bad loans as a proportion of their lending book.
Non-performing loans in Santander's Spanish business rose to 6.4 percent of total credit at the end of September versus 5.75 percent at end June. Chief Executive Javier Marin said the level could reach 7 percent in the remainder of 2013, even as the rate of increase in bad loans tails off.
Sabadell's bad loan ratio hit 12.6 percent at the end of the third quarter, above the sector average of 12.1 percent. ($1 = 0.7260 euros) (Additional reporting by Julien Toyer and Jesus Aguado; Editing by Jane Merriman and David Holmes)