(Adds Taiwan yuan deposit rates also being raised)
TAIPEI/HONG KONG, June 25 (Reuters) - The only clearing bank for yuan transactions in Hong Kong and Taiwan is raising interest rates on renminbi deposits in a bid to attract more funds as a cash crunch sweeps through China's onshore money markets.
The surprising interest rate increase comes at a time when some Chinese banks have raised one-month yuan retail deposit rates to as much as 4 percent, according to Hong Kong media reports, highlighting the fact that some lenders are borrowing in the offshore market to meet their onshore demand for funds.
Even though Beijing frowns upon banks remitting yuan funds across borders for non-trade-related transactions, bankers and traders report that offshore subsidiaries of Chinese lenders appear to be drawing on a 650 billion-plus yuan ($105 billion) deposit base in Hong Kong.
Bank of China raised the interest rate it will pay for other banks' yuan deposits to 0.75-1.05 percent from a flat rate of 0.648 percent, effective next month.
"It will enhance Hong Kong's competitiveness as an offshore yuan center," a statement from the bank said.
The ripples from China's inter-bank cash crunch haven't been limited to Hong Kong alone, with Taiwan's fledgling yuan market also beginning to feel the heat.
Bank of China's Taipei branch will raise overnight rates for yuan deposits in July in a bid to lure more yuan funds from Hong Kong, a source with direct knowledge of the matter said on Tuesday.
The branch, the clearing bank for the Chinese yuan in Taiwan, will lift rates to 0.75 percent for deposits under 50 million yuan ($8.14 million), 0.86 percent for deposits between 50 million yuan and 100 million yuan and 1.05 percent for deposits bigger than 100 million yuan, said the source.
Currently, the rate stands at 0.648 percent.
Market watchers said the timing of the increase showed the pressure under which onshore banks are under to manage their funding requirements even as Beijing has cracked down on errant lenders.
In the money market, short-term rates continued a broad moderation, after they had shot up last week when the central bank refrained from helping banks tide over a tighter spell in a seemingly deliberate move to curb credit flowing to China's vast "shadow banking" system.
Overnight and 7-day rates eased again on Tuesday after the central bank did not drain funds, but weighted-average rates of over 5.8 percent CN1DRP=CFXS and 7.4 percent CN7DRP=CFXS respectively were still well above long-run levels.
"The interest rate hike represents a need for banks to garner as much deposits due to the fallout of the onshore cash squeeze. More banks are expected to follow suit in raising rates," said a strategist at a European Bank in Hong Kong.
Renminbi deposits in Taiwan have grown from zero to 60 billion yuan since banks were first allowed to accept them in February.
By contrast, the yuan deposit base in Hong Kong is more than 10 times that of Taiwan at more than 650 billion yuan, excluding outstanding bonds and bills.
For more news on China's cash squeeze and its impact on global markets, see ($1 = 6.1451 Chinese yuan) (Reporting by Lin Miao-jung and Saikat Chatterjee; Editing by Kim Coghill)