The Nikkei stock average fell on Tuesday, moving further away from four-month highs, as banks were sold by European and domestic players on growing frustration with governments' inability to solve debt crises in the United States and Europe.
A stronger yen, which last week hit a four-month high of 78.45 yen against the dollar on global debt woes, pressured blue chip exporters, with Canon Inc falling 2.8 percent to 3,680 yen and Sony Corp losing 2.5 percent to 2,088 yen.
Kansai Electric slumped 3.3 percent to 1,393 yen after the company halted one of its reactors due to technical glitches, sending other utilities lower on worries about tight power supply.
The yen and anxiety about US and European debt spurred a shift into defensive shares, with Internet companies, retailers and telecommunication firms posting strong gains.
Asian investors were also seen as supporting the market.
"Investors, worried about the global economy, are again turning to companies with high exposure to the domestic market," said Takashi Aoki, a senior fund manager at Mizuho Asset Management.
Telephone company NTT rose 1.7 percent to 3,910 yen. Seven & I Holdings, Japan's biggest retailer, made its biggest gain in more than two weeks, adding 1.4 percent to 2,264 yen.
The benchmark Nikkei closed down 0.9 percent at 9,889.72, having breached crucial support at its 200-day moving average of 9,903.
The benchmark has been trapped between that level and its resistance at 10,000 for over a week as investors ponder their next step, torn between mounting debt woes and relatively strong US corporate earnings, which suggest Japanese firms may also report better-than-expected figures later this month.
The broader Topix fell 0.7 percent to 853.75.
Eurozone leaders will meet on Thursday to finalise a second round of aid for Greece worth 110 billion euros ($154 billion), while political leaders remain at an impasse with the clock ticking in Washington before an August 2 deadline on the federal borrowing limit.
Rotation into domestic demand-related stocks benefited some Internet shares. Internet advertising service company Cyber Agent extended its winning streak to a fourth day, up 0.5 percent at 298,400 yen. Gree rose as much as 1.2 percent earlier, before closing down 0.7 percent at 1,847 yen on light profit-taking.
Internet shares were also supported as margin traders were detected selling Nintendo, pulling the game giant down 2.7 percent to 14,760 yen, while piling into social gaming shares.
Nintendo came within shouting distance of a 5-1/2 year low after Macquarie Securities slashed its rating to "neutral" from "outperform" and cut its target share price to 16,000 yen from 23,000 yen, citing struggling sales of its 3D-capable handheld device and pressure on earnings from the stronger yen.
"The company's focus on doing both hardware/software, while noble, will ultimately limit its ability to be relevant in a 'smartphone in every pocket' world," said Macquarie analyst David Gibson. "In particular the company is not exposed to growth in SNS, smartphone, PC and MMO games spending," said Gibson referring to different kinds of online games.
Better-than-expected earnings from IBM raised hopes that this year would be a good one for the technology sector and lent some support.
Earnings and a slew of important US macro data due this week depressed volumes with 1.5 billion shares changing hands on the main board, below last week's lukewarm average volume of around 1.7 billion shares.
The banking index was one of the biggest losers among the 33 Topix subindexes, dropping 1.3 percent to a 2-1/2 week low. Mitsubishi UFJ Financial Group fell 2.5 percent to 383 yen, while Sumitomo Mitsui Financial Group dropped 1.3 percent to 2,404 yen.