US stocks had dropped on Monday as concerns over global growth hit banks and other economically sensitive shares, although a late rally in energy shares left the market well above its lows of the day.
European banks led a global sell-off in financial stocks as signs of stress in the sector mounted.
Uncertainty over whether the Federal Reserve would raise rates this year also dragged down US bank stocks, pushing the S&P financial index down 2.6 per cent.
The index is off 14.6 per cent for the year, the worst-performing of the 10 major S&P sectors. It is down more than 20 per cent from its July 2015 high, confirming the sector is in the grip of a bear market.
"Investors' attitudes seem to be worsening relative to the likelihood of a global recession. I think that's what financials are reflecting - that their net interest margins are going to be further compressed under collapsing bond yields," said Mark Luschini, chief investment strategist at Janney Montgomery Scott in Philadelphia.
The yield on the 10-year Treasury note fell to a one-year low.
Shares of Morgan Stanley slid 6.9 per cent in their largest one-day drop since November 2012, while rival Goldman Sachs fell 4.6 per cent. Both closed at their lowest since 2013.
Facebook Inc, Amazon.com Inc and other technology stocks that had lent strength to the market last year extended their decline from Friday. Fund managers said last year's outsized gains among some Internet stocks made them the first choice to sell now.
S&P energy index
Sharp selling in the beaten-down energy sector reversed late in the session, leaving the S&P energy index up 0.1 per cent and S&P 500 well off its lows of the day.
But Chesapeake Energy ended down 33.3 per cent at $2.04 after sources told Reuters that the natural gas company had tapped existing adviser Kirkland & Ellis to explore restructuring options. Chesapeake said it has no plans to pursue a bankruptcy.
The Dow Jones industrial average closed down 177.92 points or 1.1 per cent at 16,027.05, the S&P 500 lost 26.61 points or 1.42 per cent to end at 1,853.44 and the Nasdaq Composite dropped 79.39 points or 1.82 per cent to 4,283.75.
Falling oil prices along with concern over a worsening global growth outlook have caused a sharp sell-off in stocks this year. Investors have been searching for a catalyst that might change the market's course.
"I don't know if we've seen any tangible evidence of a turn in any macro economic conditions that would warrant a firm bottoming," Luschini said, noting the selloff in financials.
Adding to recent woes for the tech sector, Cognizant dropped 7.7 per cent to $54.05 after the IT services provider issued a weak sales forecast.
Amazon fell 2.8 per cent, while Facebook dropped 4.2 per cent.
Volume was heavy. About 10.6 billion shares changed hands on US exchanges, above the 9.4 billion daily average for the past 20 trading days, according to Thomson Reuters data.
Declining issues outnumbered advancing ones on the NYSE by 2,484 to 618; on the Nasdaq, 2,029 issues fell and 804 advanced. The S&P 500 posted 7 new 52-week highs and 97 new lows; the Nasdaq recorded 4 new highs and 495 new lows.