* BSE index down 1.68 pct, NSE index falls 1.78 pct
* Banking and financial stocks drag
* FIIs withdraw $2.55 bln in Aug, highest ever monthly outflow
Sept 1 (Reuters) - Indian shares fell about 2 percent on Tuesday, dragged by banking and financial stocks after reports of HDFC Bank's steep base rate cut on Monday sparked fears that other lenders will be able to match it only at the cost of margins.
HDFC Bank cut its base rate by 35 basis points to 9.35 percent from Sept. 1 in a move to capture wider market share, according to media reports on Monday.
The move stoked fears that pricing pressure would lead to other banks taking a hit on their net interest margins as most banks would have a base rate of 35-65 basis points higher than that of HDFC Bank.
Falls also tracked lower Asian stocks after data showed that China's manufacturing sector contracted at its fastest pace in three years in August, reinforcing fears of a sharper slowdown in the world's second-largest economy.
Foreign investors pulled out a record $2.55 billion from Indian markets in August, the highest ever monthly outflow at least since 2002 as per regulatory data.
"The volatility in the markets is largely because of factors outside the control of market participants in India," Deven Choksey, managing director, KR Choksey Securities said.
The benchmark BSE index fell 1.68 percent, while the broader NSE index declined 1.78 percent.
Financial and bank stocks took a beating, with Housing Development Finance Corp falling 3 percent and HDFC Bank losing 2.4 percent, while Axis Bank declined 4.8 percent.
Blue chip stocks such as ITC fell 19 percent, while Larsen & Toubro lost 2.55 percent.
A spike in crude oil prices on Monday led to selling pressure in stocks such as Reliance Industries, down 1.57 percent, and Coal India, down 2.9 percent.
Meanwhile, state-owned Punjab National Bank fell 5.21 percent after Fitch downgraded its viability rating by one notch to 'bb'. (Reporting by Karen Rebelo in Mumbai; Editing by Anand Basu)