* Deutsche Bank earnings hit by 1.2 bln eur litigation provisions
* UBS forced to hold extra capital to deal with future litigation
* Deutsche down 2.5 percent, UBS down 6.5 percent
ZURICH/FRANKFURT, Oct 29 (Reuters) - The cost of cleaning up the banking industry dominated third-quarter results from Deutsche Bank and UBS on Tuesday, with both banks taking unexpected hits for potential legal costs that overshadowed their day-to-day performance.
Deutsche, Germany's largest bank, set aside an extra 1.2 billion euros ($1.7 billion) to deal with potential litigation costs, depressing its quarterly pretax profit to 18 million euros against an expected 642 million.
Its shares were down 2.5 percent at 0850 GMT.
Swiss rival UBS's third-quarter net profit of 577 million Swiss francs ($644 million) beat the 537 million forecast, but the bank said it would miss a key medium-term profit target because its financial regulator was forcing it to hold extra capital to deal with potential litigation costs.
Its shares were down 5.7 percent at 0850 GMT.
Both litigation hits show the uphill struggle Europe's banks still face to cast off the shadow of scandals revealed in the wake of the financial crisis, a hangover that recently forced rivals like J.P. Morgan and Rabobank to set aside billions of dollars for lawsuits and fines.
"Just as we thought the regulation might be over, back it comes," said Andrea Williams, European equities fund manager at Royal London Asset Management, referring to the news from UBS.
"I don't think anybody anticipated the regulator required more capital."
Deutsche's litigation reserves - its war chest to deal with potential legal costs - stands at 4.1 billion euros after the charges booked in the third quarter. "We expect the litigation environment to continue to be challenging," the bank said in a statement, signalling that the worst may not be over.
More than a dozen banks and brokerages, including Deutsche, J.P. Morgan and Citigroup, are under investigation by regulators over the possible manipulation of benchmark rates - including the London interbank offered rate, known as Libor - which are used to price trillions of dollars' worth of loans.
Unlike rivals Barclays and UBS, Deutsche has not yet reached a settlement over allegations. "The investigations underway have the potential to result in the imposition of significant financial penalties and other consequences for the bank," Deutsche said in its third-quarter report.
In Zurich, UBS said its financial regulator FINMA was forcing the bank to hold extra capital to deal with heightened operational risk related to "known or unknown litigation, compliance and other operational risk matters".
The measure means the bank's target of achieving a 15 percent return on equity (ROE) by 2015 will be pushed back by at least a year, UBS said.
"Consensus did not price in the 15 percent ROE target, so that's less of a worry," said Kian Abouhossein, a London-based banking analyst with JP Morgan who rates the stock 'overweight'.
"The real worry is that there are more litigation charges."
Several regulators have recently launched investigations into the potential manipulation of foreign exchange markets, and UBS said it was also conducting an internal review.
"We have taken and will take appropriate action with respect to certain personnel as a result of our review, which is ongoing," it said, without elaborating.
Matt Spick, a London-based analyst at Deutsche Bank who rates UBS as a 'buy', said the potential for FINMA to require UBS to hold additional capital to cover litigation risk had "absolutely not" been expected.
"Finma are effectively saying we think you need an extra 3 billion Swiss francs in capital against litigation issues," said Spick.
UBS repeated its commitment to paying out 50 percent of profits once it hits a common equity tier one ratio, under Basel III rules, of 13 percent, expected next year, but analysts remained wary.
"A meaningful capital return won't be until 2015, a year later than most of us were hoping," Citi analysts said.
Both UBS and Deutsche also highlighted difficulties in their day to day operations. Revenue from Deutsche's profit engine - sales and trading of debt - fell by 48 percent to 1.2 billion euros, compared with the year-ago period.
Weaker trading income has already hit rivals like Credit Suisse and Goldman Sachs after the Federal Reserve wrong-footed markets with a decision to continue its bond buying stimulus instead of starting to wind it down.
At UBS, the bank beat expectations for overall earnings. Analysts said this was largely because of one off gains including the release of deferred tax earnings, but that UBS's turnaround story remained on track.
"The UBS story is still intact in terms of becoming a private bank and equities investment bank," said Spick. "All the targets are now pushed back by about twelve months because of the scale of litigation and perhaps slower rises in interest rates, but the end-point is still the same."
($1 = 0.7254 euros)
($1 = 0.8955 Swiss francs)
(Additional reporting by Edward Taylor and Arno Schuetze in Frankfurt; Writing by Laura Noonan; Editing by Mark Potter)