* To cut 9,600 full time positions in overhaul
* To halt dividends payment for time being, retain earnings
* Expected 700 mln euro writedown seen prompting Q3 net loss
* Expects small net profit for 2016 (Adds CEO, investor, analyst comment, Finance Ministry, detail, shares)
By Jonathan Gould
FRANKFURT, Sept 29 (Reuters) - Germany's Commerzbank will cut more than a fifth of its workforce and suspend its dividend as it tackles the challenges of low interest rates, weak profits and the shift to online banking.
Germany's second biggest lender said on Thursday it plans to cut 9,600 of its 45,000 full-time positions, a more drastic move than the 10 percent staff reduction at larger rival Deutsche Bank, which remains under pressure for deeper cost cuts.
Squeezed by the European Central Bank's money printing policy, German lenders have been seeking ways to boost revenue by passing on costs to corporate customers and increasing fees for retail depositors, but profit margins remain thin in one of Europe's most competitive banking markets.
Commerzbank said its overhaul, which includes merging its four main business segments into two and moving 80 percent of its processes online, would make its earnings less volatile.
Chief Executive Martin Zielke, who has been working on the plan since taking the helm in May, was due to lay out details at a news conference at 0930 GMT on Friday.
"We simply don't earn enough money to lead the bank sustainably and successfully into the future. And this situation will get worse if we don't do something about it," he said in a draft note to employees inadvertently posted on the bank's internal website and seen by Reuters.
The changes are expected to prompt a writedown of around 700 million euros ($784 million) in the third quarter, leading to a quarterly net loss, Commerzbank said. It expects to turn a small net profit in full-year 2016, down from 1.1 billion euros last year, it said.
Market reaction to the announcement -- parts of which had been reported by media in recent days -- was muted, with Commerzbank's shares trading 1.7 percent lower at 5.89 euros by 1330 GMT, lagging a 0.9 percent rise in the STOXX Europe 600 banking index.
Commerzbank's shares have fallen by nearly 40 percent since the start of the year, compared with a 24 percent drop in the banking index.
On jobs, Commerzbank said it would also aim to add 2,300 positions in areas where business was growing, which would ease the net reduction to 7,300.
Commerzbank's supervisory board was reviewing the plans in a meeting on Wednesday and again on Thursday. Employee representatives have said they would resist job cuts.
Bankhaus Lampe analyst Neil Smith said the staff cuts were large but Commerzbank's target of reducing its annual cost base to 6.5 billion euros by 2020, from 7.2 billion last year, fell short of his expectations. Smith said he had also hoped Commerzbank would make faster progress on winding down its exposure to the troubled ship financing sector.
"If they were able to exit shipping quickly and at not too big a cost, they might be able to restore the dividend rapidly afterwards," said Smith said, who has a "Buy" recommendation on the stock.
Commerzbank said it would cease dividend payments for the time being to cover restructuring costs estimated at 1.1 billion euros.
One of the bank's top 10 shareholders said the drastic cost-cutting would be hard for employees but was unavoidable to make the bank more efficient.
"I assume Commerzbank won't pay a dividend before 2020, and that is terrible," said the investor, who declined to be named.
Germany's Finance Ministry declined comment. Berlin holds a stake of more than 15 percent in Commerzbank, a legacy of its 18 billion euro bailout of the lender in the financial crisis.
Commerzbank plans to merge its business dealing with medium-sized German companies with its corporate and markets segment. It also plans to cut back trading activities in investment banking to help reduce earnings volatility and free up capital for use elsewhere.
The restructuring is expected to lift net return on tangible equity to at least 6 percent by the end of 2020 from 4.2 percent last year. ($1 = 0.8927 euros) (Additional reporting by Andreas Kroener and Alexander Huebner; Editing by Victoria Bryan and Keith Weir)