UPDATE 1-Top UK regulator sees problem with foreign money laundering rules

* BoE deputy governor says money laundering rules damaging

* Some emerging economies cut off from financial markets

* Comments follow hefty U.S. fines for European banks

* BoE also sees some hit to liquidity from EU regulation (Releads with comments on money laundering)

By David Milliken

LONDON, Nov 4 (Reuters) - The over-zealous application ofanti-money laundering rules is hampering British banks abroadand cutting off poorer countries from global financial markets,a top Bank of England regulator said on Tuesday.

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

British banks including HSBC, Standard Chartered and RBS have been fined hundreds of millions ofdollars by U.S. regulators in recent years, although Bailey didnot mention the United States directly.

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

"We have no sympathy with money laundering, but we arefacing 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 offfrom the mainstream banking system."

"It cannot be a good thing for the development of the worldeconomy and the support of emerging countries ... that we getinto that situation," he added.

British banks have become increasingly reluctant to dealwith some countries, sometimes with legal consequences. Thelargest money transfer business in Somalia, Dahabshiil, tookBarclays to court last year after the latter withdrewbanking services.

British media have also reported cases of charities withoverseas operations having bank accounts closed, as banks judgethe small profits from providing the accounts do not compensatethem for the costs of checking everything is in order.

BNP PARISBAS CASE

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

Matters came to a head in June when France's BNP Paribas was fined $8.9 billion and temporarily barred fromaccessing 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 theissues that come up in this field ... because some of theconsequences 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 sincethe financial crisis may have increased frictions and costs inwholesale financial markets.

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

David Rule, the BoE's executive director for prudentialpolicy, said banks had responded to regulatory incentives andincreased their focus on the real economy, rather than financialmarket trading for its own sake. (Additional reporting by Andy Bruce; Editing by Tom Heneghan)