The British bank booked a further 254 million pound ($331 million) provision for soured debts, less than half what analysts had expected, and said provisions for the year would be at the lower end of a 3.5-4.5 billion pound range previously given.
NatWest shares jumped 6% as investors cheered the bank's improved core capital ratio of 18.2%, which analysts said gave it scope to resume dividends if regulators lift a ban on shareholder payouts introduced earlier in the pandemic.
Chief Executive Alison Rose told reporters she planned to resume paying dividends "as soon as possible".
Despite the better than expected profits and lower bad loan charges however, NatWest, in common with its peers, warned that its third-quarter results did not capture the expected impact of the latest government measures to curb the pandemic.
NatWest struck a more cautious tone than rival banks including Lloyds, which on Thursday hailed a boom in demand for mortgages.
"The outlook does remain very uncertain as we continue to deal with the impacts of the pandemic on the economy, and it is a very stressful time for businesses and consumers," Rose said.
NatWest posted pretax profit of 355 million pounds for the July-September period, compared to a 75 million pound loss forecast by analysts.
The bank remains 62% owned by taxpayers following its bailout in the 2008-09 financial crisis.
Before the pandemic the bank had been stockpiling capital to give it the firepower to buy back government-owned shares, but a fall in bank stocks since the coronavirus crisis has delayed this plan.
"Given the scale of capital surplus, subject to regulatory approval, there is little doubt that NWG has capacity for some form of capital return during 2021," said Ian Gordon, banking analyst at Investec.
He cautioned however that he did not expect a full-year dividend as NatWest may still make a loss over the whole of 2020.
Competitors Lloyds, HSBC and Barclays also set aside smaller provisions in their earnings compared to earlier in the year, as government financial support measures delay some economic pain to next year.
Lloyds' and NatWest's market values have roughly halved this year due to the tough outlook.
NatWest plunged into the red in the first half of the year on a 2.9 billion pound provision against potential loan losses.
"With concerns rising that the spike in Covid cases could lead to a double-dip recession, the bad debt monster could be back to bite next year," said Susannah Streeter, analyst at Britain's biggest online fund platform Hargreaves Lansdown.
(Reporting by Iain Withers and Lawrence White; Editing by Rachel Armstrong, Jon Boyle and Jan Harvey)
By Iain Withers and Lawrence White