BEIJING, Dec 12 (Reuters) - A group of small- and medium-sized Chinese banks including China Minsheng Banking Corp has started a 3 billion yuan ($480.3 million) rescue fund to guard against financial risks as the country frees its interest rate market and as its economy slows.

The group of 22 banks and one insurance firm have banded together to start the fund with 10 percent cash upfront, said Shi Jie, an assistant to the chairman of Minsheng Bank.

The remaining 90 percent of the fund is backed by guarantees from members to provide financing when needed, he told a news conference. Members pay at least 10 million yuan to join the fund and get up to 500 million yuan of financing when in need.

The arrangement underlines worries among analysts that Chinese banks are ill-equipped to handle financial risks having been coddled by state-guaranteed interest rate margins for years. Small banks are considered the most vulnerable.

'Only when small- and medium-sized banks come together to develop, will everyone feel there is sturdy backing behind each of our lonely battles,' said Li Zhenxi, chairman of Baoshang Bank, a member of the fund.

The rescue fund will help members manage liquidity risks arising from emergencies such as credit rating downgrades, large outflows of short-term deposits and choppy financial markets, said Shi.

Most of the members of the rescue fund are Chinese city banks such as Gansu Bank, Fudian Bank and Zhengzhou Bank, sources familiar with the fund told Reuters.

Shaken by China's banking crisis in the early 2000s when its top four banks became insolvent and needed a massive state bail-out, Beijing has kept banks on a tight leash by fixing maximum deposit rates and minimum lending rates to guard their profits.

Analysts say such central planning perpetuates wasteful investment as banks do not properly price in risks when lending, and are instead encouraged to lend generously and cheaply to big state firms.

Beijing is paying heed to such criticisms and has freed China's rates market slightly in two moves this year to give banks more freedom to set deposit and lending rates.

But at the same time it wants liberalisation of the rates market to be gradual to reduce financial risks, which have grown in the past year as more companies struggle under the weight of China's cooling economy and default on their loans. ($1 = 6.2460 Chinese yuan)

(Reporting by Zhao Hongmei, Zhang Shengnan and Koh Gui Qing; Editing by Sanjeev Miglani) Keywords: CHINA BANKS/

(guiqing.koh@thomsonreuters.com)(+86 10 6627 1242)(Reuters Messaging: guiqing.koh.reuters.com@reuters.net)

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