WELLINGTON/SYDNEY, July 15 (Reuters) - The World Bank is

preparing a financial lifeline for Pacific Island nations,

backed by the U.S. and Australia, as an exodus of Western banks

from the unprofitable market prompts concern that China could

fill the vacuum in the strategic region.

Without a backstop, many of the 18 small countries and

territories of the Pacific Islands Forum, spanning 30 million

square km (10 million square miles) of ocean, risk being cut off

from global finance as Western banks leave the less-developed

region, a situation an Australian official involved in the plan

called "Armageddon".

The $77 million proposal would initially enable emergency

access to dollars or other major currencies that the far-flung

island nations would need for trade and remittances if Western

banks cut ties, the World Bank said in an email.

The region, which Washington has long considered its

maritime neighbourhood, is caught in a superpower battle for

influence as China makes steady advances.

Nauru, Solomon Islands and Kiribati switched diplomatic

recognition from Taiwan to Beijing in recent years, and the

Solomon Islands has struck security and policing pacts with

China that sparked alarm in the U.S. and Australia.

Banking curbs after the 2008 financial crisis have made

Western lenders cautious about ties to the Pacific, where banks

and regulators often lack the resources to find and prosecute

financial crimes, raising the risk that banks get embroiled in

embarrassing and expensive scandals.

There is also little prospect of profit from the region's

tiny, remote populations to entice banks to bear the cost of

helping raise compliance standards.

CHINESE INTEREST AS WESTERN BANKS EXIT

"The proposed World Bank project is a creative way of

addressing the challenge of de-risking and small scale in

Pacific Island countries," said Lalita Moorty, the World Bank's

East Asia and Pacific director for prosperity.

Without access to overseas banks, Pacific countries would

struggle to receive remittances - a key component of their

economies - welcome holidaymakers or trade with the wider world.

Already as competition wanes, the cost of remittances has

increased to some of the highest globally.

"It can create instability for the financial system," said

Denton Rarawa, senior economics adviser at the Pacific Islands

Forum.

Between 2011 and 2022, the region lost 60% of its

correspondent banking relationships, where Western banks partner

with local ones to enable transactions in international

currencies.

ANZ Bank has sold assets in Papua New Guinea, Westpac tried

to sell its Pacific business and Nauru's only lender,

Australia's Bendigo Bank, announced plans to leave in 2025.

China may be seeking to fill that gap.

Bank of China has opened an office in Papua New Guinea and

signed a memorandum of understanding with Nauru to look at how

they could step in if Bendigo Bank leaves. Vanuatu last week

asked Bank of China to set up a branch.

Bank of China did not respond to a request for comment.

Chinese banks have in recent years expressed interest in the

Solomon Islands, Tonga and Samoa, the central bankers of those

countries told Reuters, although nothing has eventuated.

'LIGHT AT THE END OF THE TUNNEL'

"We're well aware of the geostrategic interest of our region

between U.S., China and Australia," said Cook Islands Prime

Minister Mark Brown, the current chair of the Pacific Islands

Forum.

"What we're saying is that if you're not going to address

concerns and issues we have, Pacific countries will start

looking elsewhere for support."

The U.S. and Australia were spurred to act against the

festering problem in the past two years by planned exits like

Bendigo's and concern that China could step in, said three

officials who asked not to be identified because they were not

authorised to speak to media.

A delegation of more than 20 U.S. Treasury and Federal

Reserve officials flew in for a conference in Brisbane last week

with Australian and Pacific Islands officials, opened by a video

message from Treasury Secretary Janet Yellen.

Under the plan, the World Bank will also study ways to make

the Pacific Islands more attractive to global banks, including a

mechanism to aggregate payments from various countries to help

achieve economies of scale, the World Bank said in a statement.

The Washington-based global lender's board is expected to

approve the plan within a few months. Commercial banks will bid

to run the facility, which can be used in an emergency to

process transactions in dollars and other currencies.

Countries will be charged to use the facility so it does not

undercut private providers. They will also need to meet

standards on financial crimes regulation.

The U.S. and Australian effort convinced at least some

conference attendees that after more than a decade of talk, a

solution is close.

"We can see the light at the end of the tunnel," Reserve

Bank of Fiji Governor Ariff Ali told Reuters. "I'm confident

we'll find a solution and I'm confident we're making progress."