NEW DELHI/MUMBAI (Reuters) - India's federal police detained two employees of Punjab National Bank PNBK.NS, the state-run lender that says it has been the victim of a $1.77 billion fraud, in the first arrests in a fast-widening probe into the country's biggest-ever bank scam.

A Punjab National Bank logo is pictured outside its branch in New Delhi, India, February 16, 2018. REUTERS/Saumya Khandelwal

Gokulnath Shetty and Manoj Kharat are suspected of steering fraudulent loans to companies linked to billionaire jeweler Nirav Modi and entities tied to jewelry retailer Gitanjali, which is led by Modi’s uncle, Mehul Choksi.

India’s Income Tax department warned in an internal note seen by Reuters that domestic banks could take a hit of more than $3 billion from loans and corporate guarantees provided to Modi and Choksi.

The arrests, late on Friday, came two days after India’s second-largest state-run lender said it had been hit by massive fraud, sending its share price tumbling.

The accusations against the two relatively junior PNB officials were detailed in the lender’s disclosure, and also contained in a preliminary police report.

The Central Bureau of Investigation (CBI) also arrested a third person, Hemant Bhat, whom a source described as the “authorized signatory” of the companies tied to Nirav Modi.

All three appeared before a hot, packed courtroom in Mumbai on Saturday afternoon, where they were ordered to remain under police custody until March 3 to allow the CBI to continue its investigation. No charges have yet been laid.

“CBI must get fair chance to investigate this very serious offence, which has consequences for the country’s economy,” said judge S R Tamboli, as PNB employee Shetty shifted nervously and blinked frequently. The other two stood passively.

Family members of the accused present at the court defended them, saying they were innocent.

Kharat’s uncle told Reuters the PNB employee was “just following orders of superiors” and added “he wasn’t aware of what he is doing”.

PROBE WIDENS

A police source said six more PNB employees were “being examined” after the CBI conducted additional searches at the PNB’s branch in southern Mumbai where the alleged fraud took place.

Police sources say Modi, whose high-end jewelry has been worn by Hollywood stars including Kate Winslet, and Choksi left India last month and their whereabouts are unknown. Neither Modi nor Choksi have so far commented on the allegations.

Gitanjali has previously denied Choksi’s involvement in the fraud and said he would take “necessary legal action” to get his name removed from the police case.

TV station NDTV on Friday reported Modi was at a suite in a New York hotel, citing household staff who answered the door.

On Saturday, a police source said that the CBI had sent a notice through Interpol in a bid to help locate Modi.

Meanwhile the Enforcement Directorate, India’s financial crime agency, said on Saturday it conducted additional searches at 21 locations of companies tied to Modi, seizing 250 million rupees ($3.89 million) in precious stones, metals and jewelry.

Both authorities have conducted dozens of raids since PNB disclosed the fraud, targeting PNB, Modi and Choksi, with the Enforcement Directorate now having seized diamonds, gold and jewelry worth 56.7 billion rupees.

A tax department spokeswoman told Reuters officials had seized 29 properties and 105 bank accounts linked to Modi.

FINANCIAL IMPACT

The biggest bank fraud in India’s history has sent rumbles through India’s financial system, raising fears about the scale of problems in the banking sector that is already saddled with $147 billion of soured debt.

PNB said on Friday it was running an audit of its systems to prevent a recurrence of such a fraud, but did not see a long-term hit to its operations. The bank, which has $120 billion in total assets, has lost more than a fifth of its market value since it disclosed the fraud.

The Hindu newspaper reported on Saturday that the Central Vigilance Commission, which investigations corruption in the government, has summoned senior officials of the Reserve Bank of India and the Finance Ministry to assess how all internal checks and balances failed to detect the fraud.

PNB officials were also summoned, the report said, citing an official aware of the development.

The RBI did not reply to an emailed request for comment. A Finance Ministry spokesman was not immediately reachable.

Scrutiny of banks' technical systems will intensify even further after India's City Union Bank Ltd CTBK.NS on Saturday said it had suffered three "fraudulent remittances" of nearly $2 million that had been pushed through the SWIFT financial platform.

The case was reminiscent of the $81 million cyber heist that hit Bangladesh’s central bank in 2016.

($1 = 64.2400 Indian rupees)