* U.S. family sues Bank of China in terrorism financing case
* Once supportive, Israel reconsiders sending witness
* Netanyahu faces Chinese pressure over law suit - report
JERUSALEM, Nov 1 (Reuters) - Long determined to deprive Islamist groups of funding, Israel has unexpectedly hit the brakes in a U.S. court case centred on allegations that the Bank of China knowingly let cash flow to Palestinian militants.
Apparently reluctant to send a former Israeli intelligence official who is a potentially crucial witness to testify in New York, Prime Minister Benjamin Netanyahu faces accusations from his critics that he might let the case unravel rather than put bilateral trade ties with Beijing at risk.
The law suit against the Bank of China was brought by the American family of Daniel Wultz, a 16-year-old killed while on holiday in the Israeli city of Tel Aviv in a 2006 suicide attack claimed by the Islamic Jihad faction during a Palestinian uprising.
From the horror of the attack grew a complex investigation that has already seen the governments of Iran and Syria convicted in a U.S. court for sponsoring Islamic Jihad. They were ordered to pay $323 million in damages to the Wultz family, but have yet to hand over the money.
The family alleges that the Bank of China allowed money from Syria, Iran and elsewhere to pass unhindered through its accounts to the Islamic Jihad, listed by Washington as a terrorist organisation, in violation of U.S. financing laws.
The bank, which is China's fourth largest lender, denies any wrongdoing and is contesting the case. Contacted in China, the state-controlled company declined to comment further.
Israeli newspaper Yedioth Ahronoth said last month that Netanyahu, looking to pave the way for a high-level visit to China in May, had promised not to let any civil servant, past or present, give testimony which might help the prosecution.
Netanyahu's office declined to comment on the report.
A Chinese Foreign Ministry spokeswoman in Beijing, Hua Chunying, said she was not aware of the case. She added that China implemented "a strict oversight ... to prohibit any institution from supporting terrorist activities in any way".
Showing discontent within the Israeli establishment, the former head of Israel's Mossad spy agency has said he was ready to defy Netanyahu and testify himself if the original witness, ex-intelligence official Uzi Shaya, was muzzled.
"If they ask me, if I receive a request from a U.S. court to testify, I would go testify at any time," Meir Dagan, who led Mossad from 2002-2010, told Reuters.
A regular critic of Netanyahu, Dagan helped to orchestrate Israel's international drive to strangle militant funding.
"I think that a continued war on terror, and a clear Israeli position on the matter, should be our priority. Because we, unlike other countries, suffer from terrorism all the time, and apparently we will continue to suffer from it," he said.
Israel was the driving force behind the Wultz case against the Bank of China, but alarm bells rang for the family in July when Shaya did not give his eagerly awaited deposition. Shaya could not be reached to explain his failure to testify.
"The Israeli government wanted to initiate this case in support of stopping those who help finance terrorism and it provided critical information," said Daniel's father, Yekutiel Wultz, who was wounded in the blast on April 17, 2006.
Israel was keen for the family of Daniel, who was the only U.S. victim of an attack that killed 11 people, to file the suit in the United States to take advantage of anti-terrorism laws that banks operating on U.S. soil must honour, a legal source close to the case said.
In their 2008 suit against China, the Wultzs say the bank's "conduct was criminal in nature, dangerous to human life, outrageous, intentional, reckless and malicious, and so warrants an award of punitive damages".
Bank of China is expanding its U.S. network, and this case could have implications for its future development in America.
In an emailed statement, Wultz, who lives in Florida, did not speculate why there was a hold-up in the testimony, saying only that the family was "determined to see this through".
U.S. authorities issued a subpoena to Shaya when he visited Washington in September, ordering him to make his deposition on Nov. 25.
The prosecution has said it hopes he will confirm that Israel had told China about accounts that Islamic Jihad, which largely operates out of the Gaza Strip, was covertly using to launder funds from Iran and to pay for their operations.
According to court transcripts seen by Reuters, the Bank of China has denied any knowledge of a meeting in 2005 when Israeli officials, including Shaya, allegedly told their Chinese counterparts about suspect bank transactions.
Judge Shira Scheindlin, hearing the case in the Southern District of New York, has written to Israel's Justice Ministry on at least three occasions this year seeking information on whether it planned to let Shaya testify.
Addressing a court session on July 19, she told lawyers it made sense to her that China would not want Shaya to testify.
"It seems pretty plain to me right now that that would be their wish," she said, according to a transcript of the hearing reviewed by Reuters.
"If the decision is no ... that may be a make-or-break decision for this case," she said, adding: "This may be the only person who really has the knowledge as to what transpired at the (2005) meeting."
Israeli officials declined to discuss any aspect of the case, saying that they were still considering the matter.
"I will not comment on this issue," Israeli Deputy Foreign Minister Ze'ev Elkin told Reuters. "It is a very delicate issue. We are dealing with it in our way and I am not sure that it should be part of public discussion."
GAZA FAMILY, MULTIPLE ACCOUNTS
Prosecution lawyers in a Sept. 17 letter to the U.S. court said 22 members of the al-Shurafa family from Gaza had accounts at a Bank of China branch in Guangdong province. The lawyers said hundreds of thousands of dollars moved through the accounts to help bankroll Islamic Jihad operations.
Since the case surfaced, Bank of China has shut the accounts, and a member of the Shurafa family was expelled from China. The Shurafa clan owns a string of stores in Gaza, a Palestinian coastal enclave, and says it had opened legitimate accounts to pay for the import of Chinese goods.
A member of the family, who declined to give his first name but who spoke on behalf of the family, said their only dealing with Islamic Jihad was when it wired them money to pay for a consignment of school bags for a charity project.
"We are shocked at what happened. We lost our business line from China ... We are the ones who should claim compensation for huge financial losses we have suffered," he said.
Israel has lobbied countless countries over the years concerning the need to crack down on money laundering. Netanyahu himself has developed a strong rapport with U.S. policymakers, thanks partly to his image as an uncompromising figure in what the United States calls its "war on terror".
The case has generated U.S. political interest, where the family has secured support of Florida politicians, including U.S. Congresswoman Ileana Ros-Lehtinen, chairman of the influential House Committee on Foreign Affairs until January.
"The Congresswoman and Prime Minister Netanyahu have had conversations regarding this matter and want a resolution to it," her spokesman said in an email, declining further comment "due to the sensitive nature of the case".