NEW DELHI (REUTERS) - India's federal police has sealed the Mumbai branch of Punjab National Bank at the centre of a US$1.77 billion loan fraud involving billionaire jeweller Nirav Modi, state television said on Monday (Feb 19).

Three people including two employees of Punjab National Bank, India's second largest state lender, have been arrested in the biggest fraud case in the country's banking history.

Gokulnath Shetty and Manoj Kharat are suspected of steering fraudulent loans to companies linked to billionaire jeweller Nirav Modi and entities tied to jewellery 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 US$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 "authorised 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.