* Drop in bad debt, hiked interest rates lift Q3 profit
* Result in-line with analyst's expectations
* Shares fall 1.8 pct amid broader selloff (Recasts and adds shares, analyst quote and background)
SYDNEY, Aug 11 (Reuters) - National Australia Bank, the country's No.3 lender by assets, posted a 5 percent rise on Friday in its key profit for the third-quarter, thanks to lower bad-debt charges and higher interest rates on home loans.
The A$1.7 billion ($1.34 billion) cash profit, which excludes one-off items, for the three months to June 30, keeps the bank on course to meet financial market forecasts for the second-half of its financial year.
"The June-quarter result itself was sound and in-line with expectations," said David Walker, senior equities analyst at fund manager Clime Asset Management, which owns NAB shares.
"It is growing at about the rate it should be growing, given the rate that the economy is growing. It means that NAB should be able to sustain its final dividend at previous rates."
Quarterly revenues rose 2 percent.
Australia's four major banks are well capitalised and have reported record profits for years, but have been rocked by a series of scandals in the last few years that have fuelled calls for a judicial enquiry known as a Royal Commission.
On Friday, two of Australia's most senior financial officials said the top banks risked losing public trust in the wake of unprecedented money-laundering and terror financing allegations.
NAB shares fell as much as 1.8 percent to a one-week low, broadly in line with a drop in the benchmark S&P/ASX 200 index over North Korea tensions.
HIGHER MORTGAGE RATES PAY OFF
While the scandals have weighed on the major four banks, which hold a combined 80 percent or so of the Australian market, NAB shares are the best performing of the group this year after falling 1.6 percent.
NAB announced a management shake up last year and exited from its troubled British operations, focusing instead on its home market.
Like the other major banks, NAB is heavily reliant on mortgage loans and is selling non-core assets as regulators push for stronger capital controls.
NAB said it was well placed to meet higher capital ratio requirements. The Australian Prudential Regulation Authority said on July 19 that the "Big Four" banks were required to raise their Tier 1 capital ratios to 10.5 percent by 2020.
The bank said its common equity tier-1 ratio was 9.7 percent at the end of June, compared with 10.1 percent in March.
NAB's net interest margin, a key gauge of profitability, improved following an increase in its mortgage rates in March after regulators had begun to fret about rapid growth in the sector.
While the move was seen as out of step with the central bank, which has held policy rates at record lows since August 2016, it was also seen as a welcome coolant for the hot property market.
NAB's non-performing loans slipped to 0.8 percent of gross debt, reflecting a push from Australia's prudential regulator to cut risky lending.
Bad and doubtful debt charges fell 12 percent to A$173 million. ($1 = 1.2718 Australian dollars) (Additional reporting by Christina Martin in Bengaluru; Editing by Stephen Coates and Neil Fullick.)