* China shares fall 3.4 pct in fourth straight weekly loss
* BOC Hong Kong, China Telecom outperform after H1 earnings
* China Vanke continues slide on new share issue (Updates to close)
By Parvathy Ullatil & Claire Zhang
HONG KONG, Aug 28 (Reuters) - Shares in China sank 2.9 percent on Friday, taking Hong Kong stocks down with them, led by banks after reports that August lending in China may drop sharply, trimming liquidity flowing into the market.
China's banking regulator had given banks verbal instructions that they must not rush into end-of-the-month lending as August draws to a close, bankers at several lenders told Reuters on Friday.
Chinese banks have lent around 200 billion yuan ($29 billion) so far this month, with the four biggest state-owned banks lending around 100 billion yuan, bankers said.
If lending in August continues at this level, it will lag far behind the 360 billion yuan reported in July and a monthly average of more than 1 trillion yuan recorded for the first six months of this year.
"The market had expected lending to fall in August but not so sharply," said senior economist He Zhicheng at Agricultural Bank of China in Beijing.
"Such a drop will surely weigh on the stock market, with the index possibly testing a low (for this year) for a second time," he said.
FOURTH STRAIGHT WEEKLY DROP
The Shanghai Composite Index closed down 85.707 points at 2,860.688, posting a 3.38 percent loss for the week.
On Aug. 19, it touched a low for this year of 2,761 points after a two-week market slump driven partly by worries over liquidity.
Losing Shanghai A shares outnumbered gainers 762 to 117 while turnover for Shanghai A shares dropped to one-week low of 133 billion yuan from Thursday's 145 billion yuan.
"The index may test its 125-day moving average (now at 2,750 points) as it appears to need to seek a fresh floor," said Tang Yonggang, chief strategist at Hongyuan Securities in Beijing. He added that the market's consolidation period might last longer than previously expected.
But many other analysts still believed that the index would generally move in a narrow range between 2,800 and 3,000 points in the near term, reasoning that the slump this month had washed out most of the profit-taking pressure accumulated during the market's 90-percent surge earlier this year.
The market was also weighed down recently by a series of announcements of new share supplies, including a $1.6 billion additional offer by second-biggest property developer China Vanke announced on Thursday.
Vanke tumbled 4.39 percent to 10.23 yuan, extending losses after revealing plans for a new public share offer to fund residential property projects as China's real estate market rebounds.
Minsheng Bank, China's first private-sector bank, the day's most active stock, closed down 5.2 percent at 6.43 yuan. It plans to float shares in Hong Kong, which while not directly related to its Shanghai-listed shares, would dilute its earnings once implemented.
Oil refiners were hit hard for second day as state-regulated domestic fuel prices remained unchanged despite surging global prices, disappointing market expectations that they would be raised.
Top refiner Sinopec Corp closed down 5.2 percent at 12.37 yuan, while PetroChina, the most heavily weighted stock in the index, sagged 2 percent to 13.72 yuan, ahead of its first-half earnings due on Friday.
BOC HONG KONG, CHINA TELECOM RISE AFTER EARNINGS
The benchmark Hang Seng Index finished 144.13 points lower at 20,098.62 after opening 0.8 percent firmer.
The gauge stayed above the psychologically important level of 20,000 points, but analysts see little upward momentum on the benchmark index as daily turnover continues to dwindle, staying below HK$60 billion for most of this week, compared with HK$80 billion early in August.
Turnover dropped to HK$56.1 billion from Thursday's HK$58.9 billion.
The index was down 0.6 percent in its second straight weekly drop.
The China Enterprises Index, which represents top locally listed mainland Chinese stocks, was down 1.2 percent at 11,433.98.
China Life dropped 2.1 percent, tracking the downturn in mainland bourses as investors continued to fret about a likely drying up of the liquidity that has driven the sharp rally in that market.
"It's clear the central government wants to control credit to make sure the money the banks are lending is not being used to speculate in the market. And that is the major direction for all of its policies," said Patrick Shum, president at BMI Funds Management.
BOC Hong Kong, the local unit of Bank of China, jumped 5.8 percent to a nearly four-week closing high of HK$16, after posting a lower-than-expected 5.6 percent drop in interim earnings, helped by strong fee income as the stock market boomed during the period.
Citigroup raised its target price on the stock to HK$18 from HK$16.50 as its expects the bank to be a major beneficiary of increased capital infows into Hong Kong and China and the ongoing recovery in the local property sector.
China Telecom Corp jumped 3.6 percent to HK$4.01 after the 30 percent drop in its quarterly profit beat analysts' low expectations, as revenue from the wireless business grew.
"We underestimated China Telecom's ability to simultaneously handle a large deteriorating wireline revenue base and a challenging subscale CDMA business," said analysts with Bank of America-Merrill Lynch while upgrading the stock to "neutral" from "underperform". (Editing by Edmund Klamann and Chris Lewis)