British bank Barclays will review its portfolio and cut costs to boost profitability as it grapples with tougher regulations which it said will lower its returns.

The warning on returns came as the bank reported a forecast-beating 32 percent rise in annual earnings on Tuesday, beating expectations thanks to a strong end to the year at investment bank Barclays Capital (BarCap) and lifting its shares by over 2 percent.

It's a good performance at BarCap in Q4, bucking the trend we've seen elsewhere. It seems the investment in equities and investment banking has paid off and has given it a good tailwind going into 2011, said Mike Trippitt, analyst at Oriel Securities.

Bob Diamond, the American investment banker who took over as Barclays chief executive at the start of the year, said tougher regulations will result in lower returns and he is now targeting a 13 percent return on equity.

Barclays has previously targeted a return on equity of 13-15 percent for its retail banking operations and 15 percent for BarCap.

Diamond said he had instigated a disciplined, rigorous and continuous review of its portfolio to achieve that, after RoE sagged to just 7.2 percent last year.

He plans to take out considerable running costs and adjust our business and asset portfolio mix and said further details will be unveiled later on Tuesday.

The bank is expected to exit or scale back capital intensive businesses, and target growth on areas that use up less capital under new regulations.

Barclays follows Swiss bank Credit Suisse in saying tougher regulations will depress returns, and other banks may follow suit as their capital requirements increase.

Barclays said staff costs for 2010 rose by a fifth to 11.9 billion pounds but bonuses fell by 7 percent, including a 12 percent fall at its Barclays Capital investment banking unit.

Barclays reported a pretax profit of 6.1 billion pounds ($9.8 billion) for 2010, up from underlying profit of 4.6 billion in 2009 and ahead of the average forecast of 5.7 billion pounds, according to Reuters Estimates.

The rise was mainly thanks to reduced losses from bad debts, which fell 30 percent to 5.7 billion pounds. That was despite losses from bad corporate loans in Spain more than trebling to almost 900 million pounds due to troubles in the property and construction.

By 0830 GMT Barclays shares were up 2.8 percent at 319.5 pence, outperforming a flat European banking index.

BARCAP REBOUND

Revenues for BarCap were 3.4 billion pounds in the fourth quarter, up 20 percent from the third quarter and recovering from several quarters of decline, faring better than rivals.

Rich Ricci, co-CEO of BarCap, said he is confident the unit can hit quarterly revenue of about 3.7 billion pounds, despite its revenue falling to 13.3 billion pounds last year, down a quarter on its record 2009 performance.

Diamond said Barclays had a good start to 2011, with group income and profit in January ahead of the 2010 average monthly run rates.

He confirmed changes to the way bonuses are paid, saying that in future performance awards would be deferred over three years and would only be made if the group's key core Tier 1 measure of capital strength was at least 7 percent.

Analysts have said the bank is likely to struggle to deliver returns above its cost of capital in the coming years, which has left its shares trading at a discount to rivals.

Diamond said he aims to reduce the cost of equity to about 10 percent, from 12.5 percent last year.

The bank will not reveal the details of pay to individual board members and its top performers until the publication of its annual report.

($1=.6236 Pound)

(Additional reporting by Paul Hoskins; Editing by Hans Peters)

Credit Suisse Barclays