* Net income beats expectations on lower provisions
* Shares down on lower net interest income, but pare losses
* Bank says could pay higher dividend (Adds comment by CEO, forecasts on dividend, NII, fees)
By Silvia Aloisi
MILAN, Nov 3 (Reuters) - Italy's biggest retail bank, Intesa Sanpaolo reported lower net interest income in the third quarter and a slump in trading profit, sending its shares down as much as 4 percent.
The bank's net profit came in at 722 million euros ($790 million), higher than a Reuters' analyst consensus of 667 million, as it set aside less cash to cover for bad loans, in a sign that Italy's economic recovery is taking hold.
But the market focused on the decline in net interest income, a measure of how much money a bank makes from its retail business. It came in at 1.912 billion euros, down 9.3 percent from a year ago.
CEO Carlo Messina said Intesa's net income in the nine months to September was the best since 2008 and did not hide his frustration at the market's reaction.
Without naming them, he pointed to European rivals that also released results on Tuesday.
"Today a bank announced a capital increase, losing 10 per cent in the market, another bank announced a postponement of the targets. Intesa Sanpaolo announced the best results in years and is losing 4 per cent, (it's) really a crazy mood in the financial environment."
Banks reporting on Tuesday included Standard Chartered , which announced a rights issue, and UBS, which watered down some of its financial targets.
Intesa's shares later recouped some of their losses when Messina suggested the bank could pay more than the 2 billion euros it has earmarked for dividends on this year's accounts.
He also said net interest income was likely to improve next year and fees - a big profit engine as the bank shifts towards wealth management - would grow in double-digits.
"I think the market is punishing the stock because net interest income is a bit under pressure, although the same can be said for other banks too," Vincenzo Longo, an analyst at broker IG, said.
"(European Central Bank President Mario) Draghi appears to be preparing another cut of deposit rates, expected in December, and this will mean another hit for banks that have a lot of liquidity but do not know where to allocate it so as to have positive interest rates."
The ECB effectively charges banks for funds parked with it overnight. Draghi has flagged the deposit rate could be pushed further into negative territory.
Intesa's core capital ratio, a measure of financial strength, rose marginally to 13.4 percent from 13.3 percent - one of the highest in Europe.
Trading income was just 1 million euros in a quarter that is seasonally weak, and was also hit by market turbulence over the summer.
$1 = 0.9137 euros Reporting by Silvia Aloisi and Francesca Landini, editing by David Evans and Jane Merriman