(Fixes references in paragraphs 7, 29 and 33)
* Run on rural bank branches in Sheyang county began Monday on solvency fears
* Rumour that customer denied withdrawal set off panic
* Banks displayed stacks of cash behind teller windows to calm nerves
* Residents already rattled by rural co-op bankruptcies, fraud schemes
By John Ruwitch
YANCHENG, China, March 26 (Reuters) - The rumour spread quickly. A small rural lender in eastern China had turned down a customer's request to withdraw 200,000 yuan ($32,200).
Bankers and local officials say it never happened, but true or not the rumour was all it took to spark a run on a bank as the story passed quickly from person to person, among depositors, bystanders and even bank employees.
Savers feared the bank in Yancheng, a city in Sheyang county, had run out of money and soon hundreds of customers had rushed to its doors demanding the withdrawal of their money despite assurances from regulators and the central bank that their money was safe.
The panic in a corner of the coastal Jiangsu province north of Shanghai, while isolated, struck a raw nerve and won national airplay, possibly reflecting public anxiety over China's financial system after the country's first domestic bond default this month shattered assumptions the government would always step in to prevent institutions from collapsing.
Rumours also find especially fertile ground here after the failure last January of some less-regulated rural credit co-operatives.
Jin Wenjun saw the drama unfold.
He started to notice more people than usual arriving at the Jiangsu Sheyang Rural Commercial Bank next door to his liquor store on Monday afternoon. By evening there were hundreds spilling out into the courtyard in front of the bank in this rural town near a high-tech park surrounded by rice and rape plant fields.
Bank officials tried to assure the depositors that there was enough money to go around, but the crowd kept growing.
In response, local officials and bank managers kept branches open 24 hours a day and trucked in cash by armoured vehicle to satisfy hundreds of customers, some of whom brought large baskets to carry their cash out of the bank.
Jin found himself at the bank branch just after midnight to withdraw 95,000 yuan for his friend from a village 20 kms (12 miles) away.
"He was uncomfortable. It was late and he couldn't wait, so he left me his ID card to withdraw his cash," Jin said.
By Tuesday, the crisis of confidence had engulfed another bank, the nearby Rural Commercial Bank of Huanghai.
"One person passed on the news to 10 people, 10 people passed it to 100, and that turned into something pretty terrifying," said Miao Dongmei, a customer of the Sheyang bank who owns an infant supply store across the street from the first branch to be hit by the run.
Claiming to be a Yancheng resident, one user of Sina Weibo's Twitter-like service repeated the story on Monday about the failed 200,000 yuan withdrawal, adding that "rumours are the bank is going bankrupt."
When later contacted by Reuters online, he said he had heard the rumour from his mother when she came back from town.
Huanghai and Jiangsu Sheyang banks declined to comment.
China's banks are tightly controlled by the state and bank bankruptcies are virtually unheard of, so the crisis has baffled many outsiders.
Yet in Sheyang, fears of a bank collapse resonate.
In recent years, this corner of hard-strapped Jiangsu province has experienced a boom in the number of loan guarantee, or 'danbao', companies and rural capital co-operatives.
These often shadowy private financial institutions promised higher returns on deposits than banks, but many have since failed.
Qu Guohua, a spiky haired former migrant worker in his 50s, nearly lost 30,000 yuan in a credit guarantee scheme that went up in flames.
What saved him one day in January 2013 was a tip-off from a friend at a rural co-operative just down the street from the loan guarantee company where he had his money.
"He told me the other one was going to go out of business and I better go get my money quick," he said.
Qu managed to get his cash, but others behind him in line were not so lucky, he said.
That helps explain why lines formed so quickly once the rumours started circulating this week. Luck has it, he deposited the cash in a bank next door: Sheyang Rural Commercial Bank.
Banks are different than credit co-operatives and guarantee companies in that they are regulated by China's banking watchdog and subject to strict capital requirements.
On Wednesday, officials' painstaking efforts to drive that message home were in full swing.
Bank managers stacked piles of yuan behind teller windows in full sight of customers to try to reassure them that they had plenty of cash on hand. Local officials used leaflets, radio and television to try to calm nerves.
Near one of the troubled banks, a branch of the China Construction Bank - one of China's 'Big Four' state-owned banks - was running a ticker message on an electronic board over the entrance stating: "Sheyang Rural Commercial Bank is a legal financial organisation approved by the state, just like us".
While small groups of depositors still gathered at several bank branches in and around this part of Yancheng, some arriving by motorbike, others by three-wheeled motor vehicles common in the Chinese countryside, there were signs that the banks' efforts were bearing fruit.
Jin said he did not panic when the rumours were spreading and on Wednesday, like many others, he made a deposit.
Others, like Qu, are holding their nerve.
On a visit to see his hospitalised granddaughter, he decided to nip into a local bank where he still has about 10,000 yuan - just for a look.
"I'm not nervous about my money in the bank. It's protected by national law." (Additional reporting by Adam Jourdan, Gabriel Wildau and the Shanghai Newsroom; Writing by Pete Sweeney: Editing by Tomasz Janowski and Neil Fullick)