Nikkei posts biggest 1-day loss since 1987 crash

*Nikkei falls 9.6 pct, biggest one-day drop since '87 crash

*Nikkei down 24 pct for week and 46 pct for year

*Growing worry about financial system feeds fears

*Yamato Life bankruptcy filing spooks investors (Adds stocks, details)

By Elaine Lies

TOKYO, Oct 10 (Reuters) - Japan's Nikkei stock average fell 9.6 percent on Friday for its biggest one-day percentage loss since the 1987 stock market crash on growing fear the financial crisis will spark a global recession.

The Nikkei, which has fallen for seven straight days, lost 24 percent on the week, more than twice what it lost the week of the 1987 stock market crash. It has lost 46 percent this year.

"This is panic. New York, the currencies -- there's nothing left for us to trust," said Takashi Ushio, head of investment strategy at Marusan Securities.

"Investors are scurrying to convert to cash. A lack of confidence is coupling with panic."

Sentiment already battered by a fall in New York shares and news that a Japanese real estate investment trust had failed grew worse after a bankruptcy filing by unlisted Yamato Life Insurance spooked the market. [ID:nTKB003055]

The benchmark Nikkei .N225 sank 881.06 points to 8,276.43, its lowest close since May 2003. At one point it was down more than 1,000 points.

The broader Topix shed 7.1 percent to 840.86.

Market fears were fed by New City Residence Investment Corp's 8965.T announcement on Thursday that it had filed for court protection from creditors, making it the first Japanese real estate investment trust to fail as fallout from the credit crunch spreads [ID:nT137740].

"The Nikkei has lost close to 20 percent in three days alone, and it's certainly not as if economic fundamentals have worsened that much in that time period," said Hiroaki Osakabe, a fund manager at Chibagin Asset Management.

"It's basically all psychological. And it's not going to stop until fears about the financial system have been erased."

The U.S. Treasury Department plans to start directly injecting capital in U.S. banks as soon as the end of October in exchange for passive investment stakes, according to a financial policy source familiar with Treasury Secretary Henry Paulson's thinking. [ID:nN09535775]