By Gabriel Wildau and Lu Jianxin SHANGHAI, June 24 (Reuters) - Fears of a credit crunch in China's banking system eased on Monday as short-term interest rates fell, and the central bank said there were sufficient funds in the market but banks needed to improve their cash management and control their lending. The People's Bank of China (PBOC) has engineered a tightening of cash in money markets as it tries to rein in excessive credit growth, especially in the lightly regulated "shadow banking" sector, seeing interest rates spike to 25 percent or higher for some deals late last week. The overnight repo rate, a key gauge of liquidity in China's interbank market, fell by 193 basis points to 7.32 percent on a weighted-average basis on Monday morning, its lowest since last Tuesday. That weighted-average rate had hit 11.74 percent last Thursday. "Panic over a liquidity squeeze appears to be fading. We are lending more money out, but I did not hear about any central bank money injection into the market," said trader at a major state-owned bank in Shanghai. The PBOC said on Monday overall liquidity was at a reasonable level and instructed banks to control the expansion of lending and improve liquidity management. The benchmark seven-day rate fell to 7.47 percent from 9.25 percent on Friday, its lowest since June 13. Despite the improvement in funding conditions, stocks fell sharply with the CSI300 index of the largest listed companies down 4 percent. The financial sub-index was down 5.7 percent. Analysts and traders said the PBOC was concerned about various activities including arbitrage, speculation, and underground lending, that it thinks are increasing leverage and financial risk without supporting the real economy. "It's much easier to borrow money today, but costs remain high. Our business is apparently affected, but mainly on side business, such as wealth management," said a trader at a mid-sized commercial bank in Shanghai. "Maybe this is what the central bank hopes as the government is calling for more money to be used for real economy." A commentary by Xinhua, a state-run news agency, on Sunday said liquidity in the banking system was ample but that funds had been misdirected. "Many large companies are still spending heavily and making large purchases in wealth management products. There is also a lot of hot money seeking speculative investments and private lending is still widespread," the commentary said.