The Nifty PSU Bank index fell as much as 3.5 per cent to its lowest since March 24.
At about 11.20 am, the index was down 3.19 per cent or 109.75 points at 3,334.50.
SBI was trading down 2.89 per cent at Rs 280.60. PNB was down 4.34 per cent at Rs 137.65. Bank of Baroda slipped 4.23 per cent to Rs 154.05 and Canara Bank was down 3.91 per cent at Rs 326.
The Reserve Bank of India told banks to set aside at least 50 per cent of loan amount for cases referred to insolvency process, according to a media report on Monday, citing two bankers familiar with the matter.
The move could take its toll on banks' earnings, analysts warned. The RBI identified 12 of India's top loan defaulters on June 14 and said creditors must pursue bankruptcy proceedings against them
Banks have already provisioned about 40 per cent for NPAs, totalling about Rs 2 lakh crore , or equal to a quarter of NPAs in banking system, before RBI's move - study by CRISIL Ratings
Crisil estimates a 60 per cent haircut would be needed on top 50 NPA cases, meaning banks will have to increase provisioning by about 25 per cent this fiscal, compared with 9 per cent in the last.
Up to Friday's close, the Nifty PSU Bank index has risen 28.3 per cent in the last 12 months.