Lloyds, 40 percent owned by the government after a state bailout during the 2008 financial crisis, said on Friday it no longer expected to meet its goals to boost income and get a return on equity of over 12.5 percent by 2014, although it said its "medium-term" recovery plan remained on track.

Banks across Europe have been posting billions of dollars in losses as the euro zone sovereign debt crisis has eroded the value of their government bond holdings and hit their bond trading businesses, and as they strive to meet tough new rules aimed at preventing a repeat of the 2007-8 banking crisis.

British rival Royal Bank of Scotland (RBS.L), 82-percent owed by the government, on Thursday reported a 2011 loss of about 2 billion pounds.

Lloyds, Britain's biggest mortgage lender, said it would pay out 375 million pounds in bonuses for 2011, down 30 percent. The average bonus was 3,900 pounds for each staff member, down 24 percent.

While pay is less of an issue at Lloyds, as it does not have a large investment banking operation, all banks are under pressure to cut pay after a public backlash over bonuses.

"Last year was a year of transition as we tackle a number of immediate issues," chief executive Antonio Horta-Osorio said.

"We expect the external environment to remain challenging in 2012, with a subdued economy, continued high levels of regulatory scrutiny and political uncertainty relating to the banking sector, and the continued potential for downside effects from financial market volatility and instability in the euro zone," he added.

Lloyds shares gave up early gains and fell 2.6 percent to 35.63 pence in early morning trade. The British taxpayer is sitting on a 10 billion pound paper loss after pumping in 20 billion pounds to save Lloyds.

"The guidance is poor on revenues, margins and future returns, but better on costs, de-leveraging and asset quality, so not too dissimilar to the story at RBS yesterday," Nomura analysts said in a research note.

BETTER NEWS ON BAD DEBTS

Lloyds, which made a profit of 281 million pounds in 2010, took a 3.2-billion-pound hit in 2011 to compensate customers for the mis-selling of payment protection insurance.

These were policies typically sold to cover loan repayments if customers fell ill or lost jobs, but were often sold to people who would not have been able to claim.

Losses on bad debts fell 26 percent on the year to 8.1 billion pounds. That included 3.2 billion pounds of losses on Irish loans.

Horta Osorio said impairments should fall by about another quarter this year, signaling a fall of almost 2 billion pounds, more than analysts had expected.

Horta-Osorio last June set out a restructuring plan that will see Lloyds axe 15,000 jobs and halve its international presence. Annual cost savings from the overhaul should hit 1.7 billion pounds, 200 million more than expected.

Lloyds forecast income would fall further this year, after dropping 10 percent in 2011 to 21.2 billion pounds.

Its banking net interest margin would drop to near 1.93 percent after falling 14 basis points to 2.07 percent in 2011 due to high funding costs, it added.

($1 = 0.6369 pound)

(Additional reporting by Steve Slater; Editing by Mark Potter)

• A Permanent Economic Emergency