* Banks says $1.77 bln fraud discovered at single branch in Mumbai
* PNB says working with agencies, regulators, peer banks
* Billionaire jeweller allegedly at centre of fraud left India
* PNB shares sink for a second day, pressure other bank stocks (Adds more details, comments from police, sources)
By Manoj Kumar and Krishna N. Das
NEW DELHI, Feb 15 (Reuters) - Punjab National Bank, India's second-largest state-run lender, sought to soothe investors on Thursday after the discovery of a $1.77 billion scam at a single branch sent its shares plunging and raised fears about the scale of fraud in the sector.
Investigators launched raids across Mumbai and New Delhi, targeting offices and homes linked to Nirav Modi, a billionaire jeweller and diamond merchant the bank has accused of being at the centre of the fraud.
Modi, who has not spoken about the case so far, could not be reached for comment. His flagship company Firestar Diamond says it has no involvement in the case.
At a packed news conference in New Delhi, PNB executives said the lender was working with regulators to determine how the largest fraud to take place in India could have gone undetected for years.
"This cancer that's been going on since 2011, we have brought it out and we are resolving it," PNB's Chief Executive Sunil Mehta told the news conference.
The executives said they would take responsibility for what had happened, but fell short of guaranteeing the lender would assume any potential liabilities, saying instead it would wait for the outcome of the investigations.
News of the alleged fraud sent PNB's shares down 12 percent on Thursday, their biggest daily percentage fall since May 2004, after falling 9.8 percent on Wednesday when it made its disclosure.
The steep fall has wiped off $1.27 billion from PNB's market capitalisation in the past two days. At Thursday's close, the bank was valued $4.87 billion.
The federal police and the Enforcement Directorate, a government agency that fights financial crime, said they had begun investigations on Thursday, including into whether the fraud involved money laundering.
The investigators were focusing mainly on the jewellery stores and other businesses controlled by Modi, whose outlets spread from New York to Hong Kong and count Hollywood star Kate Winslet among their clients.
The billionaire jeweller left India on Jan. 1, before a police case was registered against him later that month, a federal police source told Reuters. His current whereabouts are unknown.
Law minister Ravi Shankar Prasad said the authorities had seized assets worth 13 billion rupees ($203 million) from Modi and initiated action to revoke his passport.
PNB's Mehta said Modi had written to the bank about a possible repayment, but had not yet come up with any concrete plan.
PNB, which has assets of $120 billion, shocked India's financial sector when it disclosed the fraud in a regulatory filing on Wednesday.
The lender said two junior officials at one of its branches in Mumbai had issued "letters of undertaking" to get overseas branches of other lenders to extend credit to "a few select account holders".
Letters of undertaking (LoUs) are issued by a bank giving some sort of a guarantee on behalf of a company. Other lenders give credit based on the LoU.
The companies that received the credit mainly had ties to Modi and another jeweller, Mehul Choksi, managing director of Gitanjali Gems, PNB has said.
Gitanjali has denied Choksi's involvement and said he would take "necessary legal action" to get his name removed from a police case.
According to PNB, the LoUs were entered into the SWIFT interbank messaging system by the employees but not registered on the bank's own systems, which executives said on Thursday had allowed fraudulent transactions to go on undetected since 2011.
SWIFT said it did not comment on individual customers or entities.
"When a case of potential fraud is reported to us, we offer our assistance to the affected user to help secure its environment," said a spokeswoman.
Opposition Congress Party leader Rahul Gandhi took a dig at the government, saying on Twitter Nirav Modi, who was seen at a gathering with Indian Prime Minister Narendra Modi at a recent World Economic Forum Event in Davos, had used that "clout" to slip out of the country.
The ruling Bharatiya Janata Party denied any link with Nirav Modi, who is not related to India's Prime Minister.
The PNB disclosure is the latest negative news to hit a banking sector hobbled by $147 billion of soured debt. India's banks recently received a $14 billion government bailout as part of broader $32 billion rescue programme.
Indian bank shares slid further on Thursday, amid worries about who else had extended credit at the behest of PNB.
Banking sector sources named top lender State Bank of India , and two other state-run banks Union Bank of India and Allahabad Bank, among those who had extended credit based on the LoUs issued by PNB that were later found to be fraudulent.
The banks did not immediately respond to requests for comment.
Axis Bank said on Thursday that it had dealt in transactions that had been guaranteed with letters of undertaking from PNB, but that it had since sold those transactions.
Some banks say PNB is liable to make good on the credit extended, although PNB maintains other banks lenders share some of the blame as they should have more closely examined the requests for credit.
Analysts warned PNB may be left on the hook.
"We await more details, but if the 'other banks' have advanced money to overseas suppliers against PNB's letter of credit, PNB would have to honour the payments, in our view, and would have to seek to recover the money from these overseas suppliers," said Morgan Stanley analyst Sumeet Kariwala, in a note to clients on Thursday.
"This could subject PNB to significant potential impairments," he wrote, adding this could increase the bank's capital requirement by 80 billion rupees ($1.25 billion). ($1 = 63.9100 Indian rupees)
Additional reporting by Mumbai and Delhi bureaus; Writing by Simon Cameron-Moore, Euan Rocha and Devidutta Tripathy; Editing by Raju Gopalakrishnan, Rafael Nam and Alex Richardson