Concerns over U.S. bank exposure to troubled Japanese banks sent financial shares tumbling Wednesday, led by Citigroup Inc., amid a meltdown in global stock markets.

U.S. banking companies, including Citi and J.P. Morgan Chase & Co., have been building their asset management and capital markets capabilities in Japan, Asia, and Europe for the last year, seeing those markets as poised for stronger growth than the more mature domestic market.

But now it appears the growth will not come anytime soon. Fitch, the U.S. ratings agency, put 19 Japanese banking companies on watch for downgrading Wednesday on concerns about their financial strength. This, plus negative reports on European bank prospects from Goldman Sachs Group and Morgan Chase, spooked investors in the large-bank stocks, analysts and traders said.

The slowdown in the U.S. economy had already battered bank stocks, and earnings, for the last two quarters. With the prospect of a slowdown in markets that were previously thought to be big opportunities for U.S. banks, investors are opting out. “There’s a whiff of global recession,” said David Hilder, an analyst at Morgan Stanley Dean Witter & Co. Still, he described the heavy selling Wednesday as “irrational.”

Some analysts said Citi is particularly vulnerable to a deteriorating Japanese economy because it has built a large local market presence and has recently expanded in Japan through its acquisition of Associates First Capital Corp. of Irving, Tex.

Rumors also rippled across Wall Street that big U.S. banking companies, including Citi, Morgan, and Bank of America Corp., had loan exposure to some of those Japanese banks.

Shares of Citi, a component of the Dow Jones industrial average, fell 7%, to close at $44.90 a share. Morgan, another Dow component, fell 7.7%, to $43.75. Even the highly regarded “processing” banking companies could not avoid the rout. Shares of State Street Corp. declined 6%, to $90.32, and Bank of New York Co. fell 6%, to $44.60.

Overall, bank stocks fell nearly twice as far as the general market. The American Banker index of 50 bank stocks fell 5%, and its index of 225 bank stocks dropped 5.6%. The Dow Jones industrial average sank 3% to close below 10,000 for the first time since October. The Standard & Poor’s 500 dropped 2.6%.

Traders described the selloff as a “panic,” and many analysts said the concerns were overblown.

For one thing, Fitch mitigated its negative ratings watch by saying it believes the Japanese government will step in, as it has in the past, and shore up at least the largest institutions. For another, U.S. companies in Japan could actually stand to benefit from a deteriorating Japanese banking industry as customers transfer money to better-quality foreign institutions.

“Citi could benefit from a flight to quality,” said Frank Barkocy, a fund manager at Keefe Managers in New York. “The impact is overstated.”

Curiously, traders said, stocks of U.S. brokerage firms that have also been growing overseas did not suffer as much Wednesday. Merrill Lynch & Co. dropped 4%, to $52.70, and Morgan Stanley dropped 3%, to $57.

“The brokers should be taking it on the chin,” said Adam Lewis, a trader at Keefe, Bruyette & Woods Inc. in New York. “They have all built up operations in Asia and Europe on the expectation of growth.”

According to a report released last month by the Basel, Switzerland-based Bank for International Settlements, U.S. banks had claims of $25.4 billion to Japanese borrowers. That’s below the $29.548 billion held by U.K. banks and $30 billion held by German banks.

Lynn Reaser, chief economist and senior market strategist for Banc of America Capital Management, said U.S. banks are better positioned than their Japanese counterparts. Indeed, many economists said they were optimistic that the recent market downturn would not do long-term damage to bank earnings.

“I think most of the banking industry would not be directly affected by a prolonged decline in the market,” she said. “The major impact would be to the extent that it affects consumer and business confidence and causes a retrenchment in capital spending and consumer spending. If that were to take place, we would see further declines in interest rates, and that would act as a buffer.”

Banks already are beginning to see a shift in assets toward certificates of deposit and money market funds, Ms. Reaser said. If the Federal Reserve Board cuts interest rates as anticipated by another half-percentage point next week, “that should help banks both directly and indirectly to the extent that it creates more lending activity and helps the credit standing of both individuals and businesses,” she said.

Still, the weakened markets have put a damper on stock and bond underwriting and other capital markets businesses at banks and have made revenue growth from asset management a challenge.

Robert McCoy, chief financial officer at Wachovia Corp. in Winston-Salem, N.C., said the weak overall stock market is a potential threat to bank income, but it is too early to say whether it will drag down earnings. “If it was protracted, of course, it could affect you,” he said. “You’d be crazy to say it won’t have an effect.”

The areas of biggest concern are falling investment banking fees, possible declines in the value of assets under management, and possible losses from brokerage margin loans to investors, Mr. McCoy said. So far, though, there have been margin calls, he said, but, “We don’t expect to have losses from them.”

Campbell Chaney, an analyst at Sutro & Co. in San Francisco, said any liquidity crisis in Japan brought on by the country’s banking troubles would probably have only an indirect impact on most regional and superregional U.S. banks. Since these institutions traditionally don’t have much, if any, lending exposure to Japanese banks, the real risk is any negative impact on the U.S. economy or local economies.

This story was reported by Liz Moyer, David Boraks, Laura Mandaro, and Patrick Reilly and written by Ms. Moyer.

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