(Corrects 17th para to show that Atilla was arrested in 2017, a year after Zarrab)
* Latest charges widen politically sensitive probe
* Charged with conspiring to evade Iran sanctions
* Economy minister defends predecessor
* Halkbank says all transactions in full compliance
By Daren Butler and David Dolan
ISTANBUL, Sept 7 (Reuters) - U.S. prosecutors have charged a former Turkish economy minister and the ex-head of one of its state banks with conspiring to evade sanctions and to use the U.S. financial system to conduct hundreds of millions of dollars of transactions to benefit Iran.
The indictment marks the first time an ex-government member with close ties to President Tayyip Erdogan has been charged in an investigation that has strained ties between Washington and Ankara. Ex-minister Zafer Caglayan was also charged with taking bribes in cash and jewellery worth tens of millions of dollars.
The case stems from an inquiry into Reza Zarrab, a wealthy Turkish-Iranian gold trader who was arrested in the United States over sanctions evasion last year. Erdogan has said U.S. authorities had "ulterior motives" in charging Zarrab, who has pleaded not guilty.
Prosecutors have now charged Caglayan and former Halkbank general manager Suleyman Aslan and two others, according to the U.S. Attorney's Office for the Southern District of New York.
They were charged with "conspiring to use the U.S. financial system to conduct hundreds of millions of dollars' worth of transactions on behalf of the government of Iran and other Iranian entities, which were barred by United States sanctions," U.S. prosecutors said in a statement dated Wednesday.
They were also accused of lying to U.S. government officials about the transactions, laundering funds and defrauding several financial institutions by concealing the true nature of the transactions, prosecutors said.
Reuters was not immediately able to reach Caglayan or Aslan for comment. Halkbank said all of its transactions have always fully complied with national and international regulations, adding that news regarding the U.S. case "misleads" the public and investors.
Relations between Washington and NATO ally Turkey, a key ally in tackling the Syrian conflict, have been strained, especially since a failed coup against Erdogan in July last year. Ankara is seeking, so far without success, extradition of a U.S.-based Muslim cleric it accuses of backing the attempt.
'NO CONCERN TO TURKEY'
Economy Minister Nihat Zeybekci defended his predecessor and said U.S. prosecutors had yet to prove their accusations.
"Caglayan did not do anything against Turkey's interests," Zeybekci told reporters. "It is no concern to Turkey if Caglayan acted against interests of other countries."
Both Caglayan and Aslan are also accused of taking bribes, according to the indictment.
"Caglayan, who was serving as Minister of the Economy... received tens of millions of dollars' worth of bribes in cash and jewellery from the proceeds of the scheme to provide services to the government of Iran and conceal those services from U.S. government officials," prosecutors said.
As a result of the scheme, U.S. banks unknowingly processed international financial transactions in violation of sanctions, prosecutors said.
Caglayan, Aslan and others indicted in the case on Wednesday remain at large, prosecutors said.
The U.S. indictment echoes charges set out in a leaked 2014 Turkish police document, reported by Reuters, which set out allegations that a "crime organisation" had helped Iran exploit a loophole in Western sanctions that allowed it to purchase gold with oil and gas revenues.
When the West prohibited the gold trade in 2013 as a sanctions violation, the police report alleged the network concocted records of shipments of food at preposterous volumes and prices to continue giving Iran access to foreign currency.
Zarrab and a Halkbank deputy general manager, Mehmet Hakan Atilla, were both arrested while in the United States. Zarrab was detained in March 2016 and Atilla a year later. Both are scheduled to appear for trial in October.
Zarrab has hired former New York City Mayor Rudolph Giuliani and former U.S. Attorney General Michael Mukasey to defend him against the charges.
Giuliani has said that both U.S. and Turkish officials remained "receptive" to a diplomatic solution due to the nature of the charges against Zarrab and the importance of Turkey as an ally.
A decree issued two weeks ago gave Erdogan authority to approve the exchange of foreigners detained or convicted in Turkey with people held in other countries "in situations required by national security or national interests".
Shares of Halkbank were down 3 percent at 13.86 lira as of 1013 GMT, underperforming the benchmark BIST 100 index, which was up 0.3 percent.
(Additional reporting by Gulsen Solaker in Ankara and Ezgi Erkoyun in Istanbul; Editing by Dominic Evans)