Banks lead China stock index down 2.9 percent

(for Hong Kong stock market reports, click [.HK]) (Adds analysis, individual stocks)

* Bank of China drops below IPO price

* Index's next chart support seen at 1,783 points

* Dairy firms tumble on contaminated milk scandal

* Oil refiners rise

By Claire Zhang

SHANGHAI, Sept 17 (Reuters) - China's main stock index fell nearly 3 percent to a new 22-month closing low on Wednesday, led by bank shares, which continued to be hurt by the turmoil in the global financial industry.

Four banking shares plunged their 10 percent daily limits, after eight such shares dropped by that margin on Tuesday.

Dairy producers also tumbled after state television said a government probe found 22 of 109 companies checked had produced milk contaminated with the toxic compound melamine, which has sickened thousands of babies. (for story, click: [ID:nPEK41322])

The Shanghai Composite Index .SSEC finished down 2.90 percent at 1,929.047 points, near the day's low of 1,922.680, in thin trade. That left it down 69 percent from last October's record peak.

The index sank 4.47 percent on Tuesday, bringing it below the 2,000-point level which many analysts and investors had seen as important support. Some analysts now see no technical support above the 2004 peak of 1,783 points.

Falling stocks in Shanghai outnumbered gainers by 691 to 225 on Wednesday, while turnover in Shanghai A shares shrank to 31.9 billion yuan ($4.7 billion) from Tuesday's 33.7 billion yuan.

"The risk of exposure to Lehman Brothers LEH.N, the problem in the milk industry, the possibility of companies going into the red in the third quarter -- it's clear why confidence is evaporating," said Zhang Yanbing, analyst at Zheshang Securities.

BANKS

China Merchants Bank (600036.SS), which tumbled its 10 percent daily limit on Tuesday, plunged a further 10 percent to 14.46 yuan on Wednesday in its heaviest turnover since April, after saying it held $70 million of debt in bankrupt Lehman Brothers LEH.N and had not yet set aside any provisions for potential losses.

The biggest bank, Industrial & Commercial Bank of China (601398.SS), also slid 10 percent, to 3.42 yuan. Bank of China (601988.SS) dropped 6.31 percent to 2.97 yuan, bringing the stock for the first time below the 3.08 yuan price in its Shanghai IPO, conducted in 2006.

Some analysts and fund managers think the market has become irrational. Chinese banks are not as exposed to the global turmoil as foreign institutions; Merchants Bank's $70 million of Lehman debt is tiny compared to its net profit of $1.94 billion in the first half of this year.

But investors are also disappointed that a surprise monetary easing announced by China's central bank on Monday may actually squeeze banks' profit margins, since benchmark lending rates were cut and deposit rates left unchanged.

"Pessimistic and desperate is what investors are feeling right now. When even such heavily weighted shares tumble like this, who can expect the index to stay firm," said Qian Xiangjing, analyst at CITIC-Kington Securities.

PROPERTY FALLS BACK

Most property shares, which had risen on Tuesday after a surprise easing of monetary policy by China's central bank, were weak on Wednesday with Vanke (000002.SZ) down 7.53 percent to 5.16 yuan.

Among dairy producers, Inner Mongolia Yili (600887.SS), named by state television as one of the companies which had produced contaminated milk, plunged 10 percent to 12.09 yuan. Bright Dairy (600597.SS), which was not named, nevertheless fell 10 percent to 4.22 yuan.

Shanghai Tyre and Rubber (600623.SS) dropped 10 percent to 4.52 yuan after saying it might post a net loss in the third quarter of this year.

GAINERS

Oil refiners were strong, partly because of recent weakness in global oil prices. Sinopec (600028.SS) climbed 1.86 percent to 9.30 yuan.

Among other gainers, real estate developer Financial Street (000402.SZ) rose 0.60 percent to 6.73 yuan after saying its managers had bought 390,000 shares of the company from the secondary market last Friday, using their own money.

Shanghai Construction (600170.SS) gained 3.17 percent to 9.10 yuan after saying it had won a contract for a hotel project worth 620 million yuan.

Shanghai Zhenhua Port Machinery (600320.SS) climbed 0.52 percent to 9.75 yuan after saying it had signed a contract with a Spanish company worth 2 billion yuan. ($1 = 6.84 yuan) (Editing by Andrew Torchia)