Overreaction by banks and investigative agencies to the Rs 12,600 crore fraud on state-run Punjab National Bank (PNB) which came to light last month could hurt essential credit disbursement to trade and industry, tempering growth expectations, industry association Assocham said on Sunday.

Supporting the calls from industry for privatising public sector banks (PSBs) in the wake of the PNB scam by accused diamantaire Nirav Modi and his uncle Mehul Choksi, Assocham said that some immediate steps should be taken for capacity building in PSBs.

"Following unearthing of the alleged scams and the media headlines, the banks are becoming cautious while there is a perceived public pressure on the regulators to act tough," Assocham Secretary General D.S. Rawat said in a statement.

Given the scale of the problem, the level of noise may be justified, but it could cause a huge loss of confidence."

"So, it is time to show immense restraint and use the adverse situation as an opportunity to fix the systemic issues," he added.

According to the industry chamber "all out efforts must be made by banks, regulators, government and India Inc to limit the collateral damage from the alleged fraud in PNB".

Pointing to the US experience of handling the global financial crisis of 2007-08, "where the authorities worked at the root of their banking system and have put in place some robust risk mitigation and prudent systems", Assocham also called for immediate steps to build capacity in PSBs "to prevent, detect and act on frauds".

"Given the technology disruption taking place and India's ambitions to enhance digital footprints, it is all the more important to put in place robust systems which are well beyond compromise," the statement added.

Last month, Assocham had said that the PNB fraud that has rocked the banking system should not halt the process of corporate lending as demoralisation would set in among PSB employees at a time of a general slowdown in private investment and a highly leveraged corporate India.

Pointing out that letters of credit (LOC) or letters of undertaking (LOU) allegedly misused by the diamond traders are legitimate instruments in global trade, Assocham said: "While we may seek long-term solutions like privatisation of the banks, the need of this hour is to rally around honest bank officers and the honest business entities which have built trust on each other."