The Sensex closed 127.5 points or 0.7 per cent lower at 17,313 while the Nifty declined 48 points at 5,226.
The next support for Nifty is at 5,200 mark, which is also the 200 day moving average.
"The trend is down. Over the last months, markets have been in a trading range of 5,100-5,400. Another 150-200 points downside on the Nifty looks possible this month," Vivek Mavani, independent market analyst & portfolio manager said.
High beta metal stocks fell sharply. The BSE metal index fell 2.6 per cent. Capital goods stocks also ended 2.5 per cent lower. However, the biggest worry was the sharp fall in banking stocks.
Both private and PSU lenders saw selling pressure amid concerns of rising non-performing loans. The bank Nifty, a crucial benchmark of banking stocks, fell sharply to end below the strong support of 10,000 mark.
Ratings agency Fitch said the cumulative gross NPLs reported at India's five largest banks that account for over a third of the system assets, increased by around 62 per cent in the June quarter from a year before, and there was also a sharp increase in restructured assets.
On the Nifty, private lender Axis Bank was among the top losers, down 4.9 per cent. Global brokerage major Morgan Stanley has downgraded the stock to underweight and cut the target price by 30 per cent to Rs 800, saying rising impairments will weigh on the stock. Private lender ICICI Bank closed 3.6 per cent lower.
Heavy equipment maker BHEL was the top Nifty loser, falling 5.1 per cent. Private steel maker JSPL declined 4.9 per cent. The stock has been under selling pressure because of a decline in steel prices. The company has also been hit by the adverse CAG report on coal.
Vedanta group stocks - Sterlite Industries and Sesa Goa - were under pressure on news that Vedanta Aluminium will shut down its 3 mtpa alumina refinery in Lanjigarh.
FMCG stocks, considered defensive bets in a falling market, gained. Only nine stocks managed to end higher on the Nifty. Mobile carrier Bharti Airtel gained 3.2 per cent. FMCG major HUL gained 1.95 per cent while IT major TCS closed 1.8 per cent higher.
The market breadth was weak with only 34 per cent stocks trading higher on the broader BSE 500.
Earlier, Japan's Nikkei average fell to a near five-week closing low as soft US manufacturing data and construction spending added to concerns about a global economic slowdown.
European markets swung between gains and losses. The euro zone is likely to have slipped back into recession in the current quarter, according to a survey that showed a seventh month of contraction for the bloc's private sector as new orders dwindled.
(With inputs from Thomson Reuters)