BENGALURU - Shares in major Indian banks took a beating on Tuesday, as fraud allegations against a top mortgage lender and a prominent bank sparked fresh worries about the health of India's financial sector.

Investors fretted about the level of exposure of the banking sector, which is already reeling under a mountain of soured debt, to troubled real estate and housing finance firms.

"There is a crisis of confidence and capitulation of sorts by existing shareholders in Indian lenders," said Umesh Mehta, head of research at Samco Securities in Mumbai.

An Indian court last week ordered a probe into Indiabulls Housing Finance Ltd on allegations of illegalities, violations and siphoning of funds by its promoters and subsidiaries, according to reports. Indiabulls has denied the allegations.

Indiabulls' merger with Lakshmi Vilas Bank Ltd LVLS.NS is also on thin ice, analysts said, after the country's central bank last week placed the private sector lender under "prompt corrective action" due to reasons including high level of bad loans. 

Indiabulls Managing Director Gagan Banga on Monday tried to assuage investors, saying the Reserve Bank of India's action on Lakshmi Vilas Bank "does not shut the door on the merger".

Indian police last week also started probing Lakshmi Vilas Bank's directors for alleged misappropriation of funds.

Shares in Indiabulls, which traded at 1,440 rupees at their peak in January last year, fell 11.8% on Tuesday, before recovering to end 4.6% higher at 267.60 rupees.

Yes Bank Ltd YESB.NS , whose exposure to the Indiabulls group equals about 22.3% of its net worth, according to Macquarie Research, plunged 22.7% to its lowest close in over a decade.

Yes Capital trimmed its stake in Yes Bank by 2.16%, the company said on Tuesday, becoming the latest entity related to founder Rana Kapoor that has cut their stake in the lender. 

IndusInd Bank Ltd INBK.NS , which Macquarie says has an exposure to Indiabulls of 9.6% its net worth, dropped 6.2%.

The Nifty Bank index fell 1.3% to its worst close in nearly two weeks. The declines also weighed on public sector banks, with top lender State Bank of India SBI.NS closing 5.5% lower and the Nifty PSU index .NIFTYPSU dropping 3.8%.

(Reporting by Chris Thomas in Bengaluru; Editing by Subhranshu Sahu and Shounak Dasgupta) ((chris.thomas@thomsonreuters.com; +91-80-6749-8695; Reuters Messaging: chris.thomas.thomsonreuters.com@reuters.net))