BoE deputy governor Andrew Bailey, who heads the arm of the central bank in charge of most day-to-day financial regulation, said British banks risked being put out of business if they tripped up on foreign money laundering rules.

British banks including HSBC (>> HSBC Holdings plc), Standard Chartered (>> Standard Chartered PLC) and RBS (>> Royal Bank of Scotland Group plc) have been fined hundreds of millions of dollars by U.S. regulators in recent years, although Bailey did not mention the United States directly.

Banks fear they could be held liable even if they are only indirectly connected to someone involved in money laundering, and HSBC's chairman Douglas Flint said in August that this was hurting poorer countries.

"We have no sympathy with money laundering, but we are facing a frankly serious international coordination problem," Bailey told British legislators. "We are seeing clear evidence ... of parts of the world and activities that are being cut off from the mainstream banking system."

"It cannot be a good thing for the development of the world economy and the support of emerging countries ... that we get into that situation," he added.

British banks have become increasingly reluctant to deal with some countries, sometimes with legal consequences. The largest money transfer business in Somalia, Dahabshiil, took Barclays (>> Barclays PLC) to court last year after the latter withdrew banking services.

British media have also reported cases of charities with overseas operations having bank accounts closed, as banks judge the small profits from providing the accounts do not compensate them for the costs of checking everything is in order.

BNP PARISBAS CASE

The BoE has expressed unease at how U.S. regulatory bodies at federal and state level can impose potentially devastating penalties on banks, including the suspension of a banking licence or removal of access to U.S. dollar finance.

Matters came to a head in June when France's BNP Paribas (>> BNP PARIBAS) was fined $8.9 billion and temporarily barred from accessing some U.S. dollar clearing markets after breaching U.S. sanctions against Sudan, Cuba and Iran.

"I have to spend a large part of my time dealing with the issues that come up in this field ... because some of the consequences of the actions taken are potentially existential," Bailey said.

Speaking at the same session, a fellow deputy BoE governor, Jon Cunliffe, said some European Union regulatory changes since the financial crisis may have increased frictions and costs in wholesale financial markets.

"Liquidity and market making does seem to have been reduced," Cunliffe said.

David Rule, the BoE's executive director for prudential policy, said banks had responded to regulatory incentives and increased their focus on the real economy, rather than financial market trading for its own sake.

(Additional reporting by Andy Bruce; Editing by Tom Heneghan)

By David Milliken