* NSE index down 0.51 pct, BSE index 0.57 pct lower
* NSE bank index falls as much as 1.83 pct
* Market expected to be rangebound in near term - analyst
By Samantha Kareen Nair
Jan 2 (Reuters) - Indian shares fell around 0.5 percent in thin trade on Monday in the first trading session of 2017, as banks fell on worries their profitability would be hit after reducing lending rates.
State Bank of India cut its so-called marginal cost of funds-based lending rate (MCLR) by 90 basis points across maturities on Sunday after a surge in deposits in old, banned 500- and 1,000-rupee notes. Other lenders also announced cuts.
Still, the effective cut in lending rates will likely be less than 90 bps given that lenders are expected to protect their net interest margins by increasing spreads charged on mortgage and other loans.
Sentiment for lenders was also hit after Prime Minister Narendra Modi urged the sector on Saturday to act with the "public interest" in mind and to channel more credit to the poor and the middle class.
The weak start to 2017 also comes as a private survey on Monday showed Indian factory activity plunged into contraction last month as Modi's currency crackdown severely hurt output and demand.
"Banks could be falling due to fears that lending rate cuts may hurt their net interest margins," said Siddharth Purohit, a senior research analyst with Angel Broking.
"The market in general is expected to be rangebound in the near term while the key focus will be on the upcoming earnings season as traders wait to see the impact of demonetisation on corporates' results."
The broader NSE index was down 0.51 percent at 8,144 as of 0537 GMT, erasing early gains, while the benchmark BSE index was 0.57 percent lower at 26,473.59.
The NSE bank index fell as much as 1.83 percent in its biggest percentage fall since Dec. 7.
SBI declined as much as 2.84 percent and Punjab National Bank fell up to 1.56 percent.
Among gainers, Eicher Motors Ltd was up 3.6 percent after rising as much as 4.8 percent earlier to its highest since Dec. 12 on strong December sales amid the government's demonetisation drive.
State-run oil refiners also rose after Indian Oil Corp announced a hike in petrol prices. IOC and Bharat Petroleum Corp gained over 1 percent each.
India's Lakshmi Vilas Bank rose as much as 1.1 percent after the lender closed a $25 million share sale over the weekend. (Reporting by Samantha Kareen Nair in Bengaluru; Editing by Subhranshu Sahu)