Asia stocks fell to multi-month lows, the euro slid and oil and higher yielding currencies weakened on Tuesday on fears that Europe's sovereign debt woes will trigger a renewed crisis in the continent's banking sector.

Heightened tensions and talk of war on the Korean peninsula also jangled investor nerves in East Asia.

Europe's fumbling response to a Greek debt crisis and bulging deficits in other euro zone countries have unnerved markets over the past six weeks, and the central bank takeover of a small Spanish lender at the weekend stoked fears of a wider meltdown.

This situation with the Spanish bank makes investors nervous because it raises suspicions that something else may be smoldering behind the scenes, said Hiroichi Nishi, equity division general manager at Nikko Cordial Securities in Tokyo.

European stocks looked set to dive, with futures for the Stoxx Europe 50 down 3.5 percent. Financial bookmakers were calling the FTSE 100 <.FTSE>, DAX <.GDAXI> and CAC 40 <.FCHI> to open down between 1.8 and 2.6 percent.

Funding conditions for banks have been tightening, with institutions in the United States increasingly reluctant to deal with firms with large exposure to Europe.

Investors are selling into every rally in the euro, said Jonathan Cavenagh, currency strategist at Australia's Westpac.

Worries about the euro debt crisis are showing signs of spilling over to the banking sector with funding costs rising, albeit from very low levels. All this will only see more demand for U.S. dollars.

Money markets have seen an increasing reluctance to lend, particularly for longer terms, raising fears that dollar-funding strains could further hobble troubled banks.

The cost of lending dollars in Singapore jumped to an 11-month high and benchmark LIBOR fixings were expected to creep higher in London later.

STOCKS TUMBLE

Japan's Nikkei average <.N225> fell 3.1 percent to mark a 6-month closing low below a key support level at 9,500. The index has fallen around 17 percent from an 18-month high in early April. <.T>

MSCI's broad measure of Asia-Pacific shares outside of Japan <.MIAPJ0000PUS> tumbled 3.6 percent to touch its lowest in 9 months.

Exporters exposed to the European market were heavy losers, with camera maker Canon <7751.T> down 2.7 percent and rival Nikon <7731.T> falling 5.8 percent.

In South Korea, the benchmark index <.KS11> lost 2.7 percent as a report that North Korean leader had told his military it may have to go to war -- but only if the South attacks -- also prompted foreign investors to sell.

A trader at a European brokerage house in Tokyo said the slide in equities was at odds with macroeconomic fundamentals and earnings trends, and was likely part of moves by investors to cut exposure to risk, with one market player's stop-loss selling forcing another to cut positions as well.

I don't think things will get to the point of a financial crisis, but the price action is similar to what was seen after the Lehman shock, the trader said.

Credit markets seized up and stocks tumbled after the collapse of Lehman Brothers in September 2008, marking the most dangerous moment of the financial crisis that roiled the world's markets and economies in 2007-2009.

EURO SQUEEZE

The euro resumed its slide as a recent short covering bounce faded. Traders said with liquidity in the foreign exchange market showing signs of drying up, investors were likely to shelter in the relative safe haven of the dollar.

The euro slipped to around $1.2300 from $1.2376 late in New York on Monday, when it lost more than 1.5 percent. Against the yen, the euro fell 1 percent to 110.53.

Investors have started to sell the euro, believing that there'll be more banks in trouble, particularly in Southern Europe, said a foreign exchange trader at a European bank in Tokyo. The euro's fall has not run its course.

The South Korean won fell 2.8 percent against the dollar, its worst daily loss since March 2009, amid a sharp rise in tensions after Seoul accused its communist neighbor of sinking one of its warships.

The U.S. dollar and the Japanese yen tend to gain when there is a spike in volatility and loss in risk appetite. The dollar was up 0.7 percent against a basket of currencies <.DXY>.

The Australian dollar extended its fall, dropping nearly 1 percent against the U.S. dollar and the yen at one point, as hedge funds and investors took profits on the higher-yielding currency's rally this year.

The fears of another financial crisis boosted the safe haven appeal of gold and U.S. and Asian government debt, with Japanese government bond futures hitting a two-year high. U.S. Treasuries also rose in Asian trade.

June 10-year JGB futures rose as much as 0.37 point to a two-year high of 140.62. The benchmark 10-year yield fell 3.5 basis points to 1.215 percent.

Ten-year Treasuries rose around 9/32 in price to yield 3.165 percent, down about 4 basis points from late U.S. trading.

U.S. crude futures fell 1.9 percent to below $69 a barrel, erasing the previous day's gains, on concerns the European crisis will choke off the nascent economic recovery. NYMEX crude for July delivery was down $1.36 cents at $68.85.

Gold weakened in Asia due to the rising dollar, which makes the metal more expensive for holders of other currencies, after a rally overnight. Spot gold was bid at 1,192.10 an ounce by 0610 GMT versus $1,194.95 an ounce at 1804 GMT.

Japan Australia South Korea Fall