Returns at top banks will shrink two thirds unless they take action to limit fallout from tougher regulation, consultancy McKinsey said on Wednesday.

In some businesses, a portion of the higher regulatory costs may successfully be passed on to customers, it said in a report into the world's top 13 lenders.

Based on 2010 data, the average return on equity (ROE) -- a key profitability benchmark -- was about 20 percent.

That will be slashed to about 7 percent by the introduction of tougher global bank capital and liquidity standards, known as Basel III and due in stages from 2013, coupled with other rules such as mandatory clearing of derivatives contracts.

Several of the new rules will be phased in over time through 2019 but for the sake of simplicity we have calculated their impact as if they went into immediate effect, McKinsey said.

Basel forms the world's core regulatory response to the financial crisis as governments force banks to hold more capital to lessen the likelihood they will need another public bailout in the next crisis.

Steps to counter the expected drop in ROE were likely to push returns back up to about 11-12 percent, rising to 12-14 percent once tweaks to pricing and business models were also factored in, McKinsey said.

Even this level is still well below the 20 percent or more banks were chalking up in the heady days before the financial crisis and above what some banks still forecast.

British group Barclays ROE improved to 9.1 percent in the first half and it is targeting 13 percent by 2013. Rival HSBC is targeting a 12-15 percent range.

McKinsey said foreign exchange, share trading and capital-light products were likely to remain profitable but returns on structured credit and rates businesses could fall up to 85 percent.

Rebuilding returns will involve a full menu of immediate actions in four areas: improving risk and capital models, raising the bar for data quality, improving financial and operational efficiencies, McKinsey said.

The findings chimed with warnings from regulators.

The Bank for International Settlements, home to the committee that authored Basel III, said in June investors in banks may need to scale back profit expectations.

Return on equity of 11-12 percent would be the long term norm, the BIS said.

(Reporting by Huw Jones; Editing by Dan Lalor)