* Over 300 charities had bank accounts closed in last two years
* Government setting up working group to tackle issue
* Banks alarmed by big fines due to tough anti-terrorism laws
* HSBC hires 35 staff to focus on charity sector
* Other banks also focus on charity clients' needs, governance
LONDON, July 27 (Reuters) - More than 300 UK-based charities have had their bank accounts closed in the last two years after being caught up in a global crackdown on illegal money flows, forcing the government to explore how to allow them easier access to the financial system.
Thousands more charities have had operations disrupted by delayed payments causing financial losses and risks to employees, Britain's Charity Finance Group, that helps to organise charity financing, told Reuters. Major charities Oxfam and Save the Children say they were amongst those hit.
The government is setting up a panel of charity executives, bankers and officials to meet in the coming months to "drive new policy thinking" to allow legitimate charities to operate unhindered, an official told Reuters.
The decision to assemble the working group comes ahead of a review by the inter-governmental Financial Action Task Force (FATF) next March of Britain's efforts to tackle money-laundering and financing of militant groups.
At the FATF meeting, Britain could face criticism of its failure to tackle the problem of charities losing access to the banking system, charity sector analysts said.
The FATF has recorded over 100 cases worldwide of alleged abuse of charities for terrorist finance. In one example in the city of Birmingham in 2011, three people were convicted of impersonating Muslim Aid charity workers to fund a bomb attack.
But legitimate charities say they have been cut off from the financial system because banks have been alarmed by billion-dollar fines meted out for breaching sanctions, anti-terror financing and anti-money laundering rules.
Charity officials say the clamp-down on charities by banks is causing government-backed aid efforts to fail, humanitarian workers to be put at risk and potential recipients to suffer.
"Save the Children believes a more aligned approach between governments, regulators, and NGOs will help to reduce financial crime, whilst ensuring critical and life-saving humanitarian work continues," the group said in a statement for this article.
HSBC and Co-Operative Bank closed the most charity bank accounts in the last two years, according to a Reuters survey of more than 30 case studies. Both banks, along with other big institutions, said they were taking action to better understand the needs and internal governance of charity clients.
HSBC SETS UP TEAM
In the last two years, HSBC hired some 35 staff to work in a team dedicated to the charity sector, according to a source familiar with the hirings. The specialists aim to ensure charities comply with global financial rules.
A problem that hit mainly smaller Muslim-related charities after September 11, 2001 attacks in America accelerated in the last few years to involve thousands of charities.
"Delayed and declined payments have become a regular recurrence in the sector with charities experiencing disruption to their objectives on a daily or weekly basis," a director at UK-based umbrella group Muslim Charities Forum, Monowara Gani, told Reuters.
Many British charities affected were reluctant to speak on the record about their experiences because they were worried that other banks might cut them off, or that donations could dry up if their banking problems were publicised.
One small human rights charity funded by Britain's Foreign Office, which did not want to be identified, closed down this year after being unable to open a bank account, two sources familiar with the situation said.
This illustrated the problem posed to British international aid policy by the banks' fear of being punished for breaching regulations, said the sources who declined to be named.
Around 20 per cent or nearly $1 billion a year of the government's bilateral assistance funds distributed by the Department for International Development are channelled through charities, according to government data.
"We continue to engage with humanitarian organisations to understand and discuss what impact the wider security context may be having on their operations overseas in conflict-affected states," said the government official, who confirmed a panel had been set up to engage with the issue.
"The humanitarian sector is struggling with a policy vacuum, leaving commercial organisations such as banks to set the risk rules for delivery of publicly-funded aid," said Mike Parkinson, policy adviser for Oxfam UK, which has encountered delays in opening bank accounts overseas.
Some banks are responding to the problem, but others are reluctant to serve a sector deemed to have a "medium-high" risk of terrorist financing in a 2015 British government report.
"We feel like banks used to be competing for charity business, but now they are pushing us away," said Tim Boyes-Watson, executive director of British-based Mango which specialises in helping charities manage their finances.
Boyes-Watson said Mango is working on creating a certification system that would aim to make approved charities easier for banks to work with, but that implementing and regulating such a scheme could prove costly.
In addition to hiring a team dedicated to the charity sector, HSBC in April sent a guide called "Keeping your Charity Safe" to 11,000 charity and non-profit customers.
"We will continue to work with the UK government and industry bodies to support the not-for-profit sector," a spokeswoman for the bank said in an email.
Co-Operative Bank has closed accounts for dozens of organisations in the last few years including branches of the Cuba Solidarity Campaign and the Nicaragua Solidarity Campaign.
Amnesty International UK in December 2016 published a report criticising the bank's handling of those closures, which were often abruptly communicated to the charities. The bank said it was unethical not to comply with legal and regulatory rules.
A spokesman for the bank said it has introduced a new "exit forum" to manage closures of charities' accounts better and will soon publish a summary of its account closure data.
UNDERSTANDING CHARITY CLIENTS
Barclays has sent a mandatory questionnaire to all of its charity clients in recent months asking them how they deal with financial crime and sanctions-related issues.
"The idea is that if we understand charity clients better and get confident in their internal governance, we should be better placed to make payments for them," said David McHattie, head of the charities team at Barclays.
McHattie said no customers have lost their accounts as a result of unsatisfactory answers to the questionnaire, but that the bank has asked some clients to improve their processes.
While Britain's government, banks, and charity officials take steps to tackle the problem, aid workers say the consequences of losing access to banking are getting worse.
"I've been talking to banks for over a year and still don't have an account, so I'm having to send money for life-saving care through Western Union which is expensive and time-consuming," said the head of one medical aid organisation operating in Syria who did not wish to be named.
Other aid organisations without bank accounts are resorting to more primitive, risky methods.
"A number of organisations I know are back to throwing bags of cash over the border into Syria," said Lisa Reilly, executive coordinator at the European Interagency Security Forum which works to improve the safety of aid workers. (Reporting By Lawrence White, Editing by Peter Millership)