By: Andrew Quinn

WASHINGTON - Saudi Arabia's drive to disrupt al Qaeda financing networks should be more strictly enforced while Yemen is emerging as a new base for terror groups plotting against U.S. and Saudi interests, a U.S. government watchdog report said on Tuesday.

The Government Accounting Office (GAO) said Saudi Arabia has made progress in the fight against terrorism, arresting and prosecuting suspects and taking steps to curtail fund-raising by extremist groups inside the country.

But it said loopholes remain, including the flow of donations from individuals and charities in Saudi Arabia to support extremist organizations outside the country as well as the nation's limited ability to crack down on cash couriers who physically transfer funds.

The report stressed there was no indication the government of Saudi Arabia is providing funding for terrorism.

But it said Washington should set certain specific performance targets on preventing terror financing to help measure efforts to stop people from bankrolling al Qaeda and other extremist groups.

The ranking Republican on the House of Representatives Foreign Affairs Committee said the report underscored the need for more action.

"It is vital that the U.S. demand more from the Saudi government in cutting off the money flow to the Islamist extremist network," Ileana Ros-Lehtinen said in a statement,

The report painted a picture of gradual improvement in Saudi Arabia's policies to combat terrorism following the September 11 attacks on New York and Washington and subsequent attacks on U.S. and Saudi citizens in Saudi Arabia.

Among the Saudi efforts are government-run rehabilitation and after-care programs to re-educate those arrested for supporting terrorism and extremism as well as for people returned from the U.S. Guantanamo detention camp.

Saudi officials said the programs had treated 4,300 people overall, but that recidivism -- which at one after-care center was put at 20 percent -- was a problem.

Former Guantanamo detainees account for most of the individuals who resumed extremist activity once leaving the after-care center, the report said. "Saudi officials acknowledge such cases illustrate the difficulties associated with assessing which participants should be released."

Another focus of concern is the situation in neighboring Yemen, where political instability was seen as a potential challenge to counterterrorism efforts.

"Despite some successes against al Qaeda, the response of the government of Yemen to the terrorist threat was intermittent due to its focus on internal security concerns," the report said.

The United States this month offered to help Yemen, the Arab world's poorest country that is battling a Shi'ite revolt in the north, separatist unrest in the south, and intensified al Qaeda militancy.

The GAO report said Saudi officials had said they were already providing Yemen with assistance on a number of areas including counterterrorism, education and health.

"Saudi officials also stated that Saudi Arabia is building an electronic fence on the Saudi-Yemen border," it said.

(editing by Philip Barbara)

--Reuters