* Mid-tier banks keep deposit rates high to attract clients
* Net profit to shrink faster at small banks this year
* Small banks diversify loan base, offer new products
By Shu Zhang and Matthew Miller
BEIJING, July 1 (Reuters) - Scrambling to attract funds in a downward market, Chinese mid-sized banks are offering deposit rates above those offered by larger rivals, a tactic that is going to hit their profit much harder while loan rates continue to fall.
China's central bank announced on Saturday it was cutting its one-year deposit and lending rates by 0.25 percent each to 2 percent and 4.85 percent respectively.
Hankou Bank Co, a small lender based in the central city of Wuhan, immediately moved to trim its one-year deposit rate but set it at 3 percent, the maximum allowed under current rules.
Bank of Nanjing Co set its one-year deposit rate at 2.58 percent, while Huishang Bank set it at 2.66 percent.
Meanwhile, big state-owned players such as Industrial and Commercial Bank of China and China Construction Bank were able to offer just 2.25 percent as depositors perceive them as safer.
With the central bank's one-year benchmark lending rate set as low as 4.85 percent, the pressure on profit margins could be twice as hard for the smaller banks than for the big banks, Barclays analysts said.
"The price war, the oldest tactic that banks use to attract deposits, is becoming more difficult," said Lou Lili, head of strategy at Evergrowing Bank Co, an emergent lender with 850 billion yuan ($137.10 billion) in assets.
Barclays estimates the most recent rate cut will shrink net profit at top lender Bank of China by 0.9 percent in 2015 and 3.5 percent in 2016.
But mid-size player China Minsheng will see its net profits shrink 1.8 percent this year and a 8.2 percent next year, Barclays said.
Narrowing net-interest margins - the difference between interest generated from loans and that paid to depositors - are jeopardising income earned from lending activities, said Zhang Jianhua, acting governor at Beijing Rural Commercial Bank Co.
"The golden age of banking of the last 10 years is over," he told a conference last month.
The banks also face tough competition from trust and wealth management companies that offer much higher cash returns.
To counteract this trend, smaller banks have started to lend more to micro enterprises and to the agricultural sector, businesses supported by the government but which also carry greater risk.
Evergrowing Bank increased its pre-provision operating profits by 30 percent in the first quarter of this year by changing its loan structure, Lou said.
That may not be enough. "Banks will shrink, especially their deposit-taking and lending businesses," said Gao Jian, former vice governor of China Development Bank. "Small and mid-tier banks are facing bigger trouble, and a greater possibility of bankruptcy." ($1=6.20 yuan) (Additional reporting by Engen Tham in SHANGHAI; Editing by Lisa Jucca.)