Nikkei plunges 9.6 pct, biggest one-day fall since '87

*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 quotes, details)

By Elaine Lies

TOKYO, Oct 10 (Reuters) - Japan's Nikkei share average plunged 9.6 percent on Friday for its biggest drop since the 1987 stock crash, wiping out $202 billion in market value on growing fears that 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 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."

Trouble hit home with the bankruptcy filing of Yamato Life Insurance, the first failure of a Japanese financial institution due to the global credit turmoil.

That shocked investors who had viewed Japan has relatively safe from much of the pain seen in the United States and Europe, and who were already rattled by the collapse of a domestic real estate investment trust and a fall in New York shares.

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.

"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."

Prime Minister Taro Aso said the Nikkei tumble could hurt the wider economy, while ordinary Japanese were increasingly gloomy.

"I see people getting fired from my company and since my salary has been reduced, I'm tightening my purse strings and have begun to think twice before I buy anything," said Maki Higuchi, a 30-year-old businesswoman.

ACTION NEEDED NOW

The market plunge came as leaders from Group of Seven powers huddled in Washington to mull other joint measures to try and stop the panic in the markets.

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.

"The U.S. government is still debating whether it would inject money into financial institutions. It needs to act now even if that would be beyond the current law," said Yoshinori Nagano, chief strategist at Daiwa Asset Management.

But participants said the market had lost the ability to move on expectations alone and that only concrete action, or firm promises and a clear timetable, would help.

The slide gained impetus from investor wariness of holding large positions ahead of a three-day weekend in Japan, with Monday a national holiday. "This has become a bit of a jinx, especially since on the last Japanese three-day weekend in September, Lehman Brothers failed," said Masayoshi Okamoto, head of dealing at Jujiya Securities.

Tech stocks were especially battered, with Kyocera Corp losing 13.3 percent to 5,660 yen and TDK Corp down 13.1 percent at 3,320 yen, but selling also extended to defensive shares that had been popular during recent falls. Fast Retailing lost 10.5 percent to 8.560 yen, becoming the biggest drag on the Nikkei 225, and Terumo Corp lost 11.6 percent to 3,820 yen.

Exporters were hit as well as the yen jumped. The dollar hit a six-month low of 97.91 yen on trading platform EBS before clawing back up to 98.83 yen .

Canon Inc lost 6.9 percent to 3,100 yen and Sony Corp shed 5.4 percent to 2,385 yen.

Financials also slid, with top bank Mitsubishi UFJ Financial Group down 8.5 percent to 710 yen and Mizuho Financial Group tumbled 11.8 percent to 330,000 yen, its lowest close since early 2004.

Trade picked up on the Tokyo exchange's first section, with 3.27 billion shares changing hands, compared with last week's daily average of 2.08 billion.

Declining stocks outpaced advancing ones by more than 8 to 1. (Additional reporting by Aiko Hayashi; editing by Edwina Gibbs)