HONG KONG, Sept 11 (Reuters) - Asian shares extended losses on Thursday, hurt by persistent instability in the financial sector, while the U.S. dollar struck a one-year high against the euro.

Heightened volatility and the potential for sharp economic weakness outside the United States convinced U.S. investors to cut their holdings of riskier assets such as emerging market stocks and commodities and for now keep their money at home.

Bank stocks including Mitsubishi UFJ Financial Group fell 5 percent after Lehman Brothers posted a record quarterly loss of $3.9 billion.

"We believe inflation concerns are now waning and the new worries are around the broadening of the economic slowdown to Europe, Japan and emerging markets. In our view, this risk is very real," said Adrian Mowat, JPMorgan's emerging markets and Asia-Pacific equity strategist, said in a note.

Bank shares took a beating with China Construction Bank, the country's second-largest bank, and Industrial and Commercial Bank of China losing more than 3 percent. Hong Kong's Hang Seng index declined 3.1 percent to a new 18-month closing low. Shares of China Mobile fell 5.3 percent on a new policy in some of the company's markets that could make the world's largest cellular operator less competitive.

Stock-index losses in Korea, Australia and India ranged from 1.5 to 2.3 percent, while the main Taiwan and Singapore indexes shed more than 3 percent.

The regional weakness put the MSCI all-country world index on course for the ninth down day of the last 10. The index hit a two-year low on Wednesday.

VOLATILE HAPPENINGS

Indications of increased volatility in stock and bond markets as well as economic deterioration in just about every part of the world has led investors to cut back on overseas risk in their portfolios, supporting the dollar.

"The market's direction points toward dollar buying," said Hideaki Inoue, chief manager of forex trading at Mitsubishi UFJ Trust Bank in Tokyo.

"What we are witnessing now is position adjustments that are part of a bigger picture, one in which investors are pulling back money from risk assets," Inoue said.

The dollar rallied, clocking a one-year high against the euro and a basket of currencies on an ongoing wave of risk aversion, while the New Zealand dollar hit a two-year low after a big interest rate cut.

The dollar's latest rally kicked off earlier in the day, after a half point rate cut by New Zealand's central bank to 7.5 percent wrong-footed many in the market who had expected a quarter-point trimming.

Risk aversion also offered a broad boost to the low-risk, low-yielding yen, which hit its highest in nearly two years against the euro, while also gaining on high-yielders such as the New Zealand and the Australian dollars.

The dollar for the most part has been rallying since crude oil prices peaked above $147 a barrel in mid July and then fell sharply.

The greenback received an added boost by the U.S. government's takeover of Fannie Mae and Freddie Mac at the weekend, which helped calm some fears of further widespread bond market losses.

Still, investors continue to shed commodity related trades in earnest as risk taking takes a back seat to the need for stability amid the slowing global economy. October U.S. light crude contracts were weak around $102 a barrel as of 1030 GMT after hitting a five-month low on Wednesday as the dollar rallied.

Crude would need to trade above $109 a barrel to break a steep downward trend in prices that has held since July 14.

The reduction in risk taking in just about every asset class has been swift and definite and has pushed up the cost of insurance against credit defaults.

"We have entered a new phase of the credit cycle marked by accelerated deleveraging. Herd recycling of risk through commodities, currencies, rates, and equities is sponsoring hyper volatility," said Brett Williams, credit analyst with BNP Paribas in Hong Kong.