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* Deposits shrink 4 pct after accounting error
* Bank says 350 mln stg share issue on track for Q2
* Lender founded in 2010 to challenge incumbents (Adds details on capital, loan-to-deposit ratio)
LONDON, May 1 (Reuters) - Britain's Metro Bank revealed the damage an accounting error had inflicted on its business on Wednesday, with a halving of its quarterly profit, a drop in its capital buffers and an exodus of major business customer deposits.
Around 800 million pounds ($1 billion) was wiped off Metro Bank's market value after it said in January it had misclassified the risk weighting on a large book of loans, triggering regulatory probes and pressuring it to raise 350 million pounds.
It said in a statement that it aims to complete the share issue in the second quarter and that it has banks standing by to underwrite the deal.
However, uncertainty caused by Britain's exit from the European Union could make that a difficult time to launch a deal, meaning Metro Bank may have to pay over the odds, equity capital markets bankers have told Reuters in recent weeks.
Metro Bank's core capital ratio, a key measure of financial strength, fell by a full percentage point in the quarter to 12.1 percent, only just above the level it targets as its minimum.
Analyst John Cronin at broker Goodbody in Dublin said the bank's results statement was a "truly horrible set of numbers" that could put pressure on the planned capital raising if investors are discouraged.
Founded in 2010, Metro Bank aimed to break the dominance of Britain's incumbent high street banks by opening branches in prominent city centre locations at a time when others were shutting hundreds of outlets.
Metro Bank said its profit before tax fell to 4.3 million pounds ($5.6 million) in the January-March first quarter, down from 8.6 million pounds a year ago, while customer deposits fell 3.6 percent in the period after it disclosed the error.
"Adverse sentiment following January's update impacted deposit growth in the quarter, with a small number of large commercial and partnership customers making withdrawals," Chief Executive Craig Donaldson said.
Donaldson said the bank aims to bring its loans-to-deposit ratio from 100 percent down to around 85-90 percent in the near term, as the outflows of deposits threatened to crimp its potential to keep lending.
Metro Bank said it still aims to grow deposits by 20 percent per year, but that the poor first quarter meant it would likely miss that goal in 2019.
The bank's shares have more than halved this year as Metro Bank seeks to restore its financial strength.
Having opened some 67 branches in Britain, enjoyed steady deposit growth and favourable customer satisfaction ratings in its early years, Metro Bank this year faces its first major test -- to restore that momentum and investor faith. ($1 = 0.7643 pounds) (additional reporting by Justin George Varghese and Iain Withers; Editing by Kirsten Donovan and Alexander Smith)