The benchmark Nikkei 225 index lost 325.62 points, or 2.02 percent, to 15,801.80 points on the Tokyo Stock Exchange. The index jumped 1.94 percent Friday. Japan's financial markets were closed for a holiday Monday.

"There still seems to be a lot of selling pressure from foreign funds. Investors will be looking to see what the FOMC decides to do next," said Shoji Hirakawa, equity strategist at UBS Securities in Tokyo.

Many investors expect the U.S. central bank's Federal Open Market Committee to cut a key interest rate a quarter point to 5 percent to prevent problems in the U.S. housing market from affecting the broader economy. An aggressive cut of half a percentage point could prove to be a shot in the arm for investor confidence in Japan's stock market.

The Bank of Japan convened a two-day policy board meeting Tuesday, but the bank is likely to keep its interest rates steady.

The Nikkei has lost 12.8 percent since the end of June, when concerns over credit markets first began to gather pace.

Among banks Tuesday, Mizuho slumped 7.9 percent to 605,000 yen while Resona Holdings dropped 8 percent to 185,000 yen.

Hitachi dropped 1 percent to 693 yen, after Friday forecasting a deeper group net loss for the fiscal first half.

The broader Topix index, which includes all shares on the exchange's first section, fell 33.76 points, or 2.19 percent, to 1,510.95 points. The topix rose 1.43 percent Friday.

In currencies, the dollar was trading at 114.88 yen at 2:50 p.m. (0550GMT) Tuesday, down from 115.17 yen late Monday in New York. The euro fell to US$1.3862 from US$1.3867.