By Manya Saini and Saeed Azhar

(Reuters) -U.S. bank stocks slumped on Monday as fears of a recession sent investors fleeing from a sector closely tied to the health of the economy and toward safe-haven assets.

The S&P 500 Banks Index, tracking a basket of large-cap bank stocks, closed down 2.4%, while the KBW Regional Banking Index fell 2.8%.

Citigroup led big bank losses with a 3.4% fall.

JPMorgan Chase (NYSE:JPM) fell 2% and Bank of America declined nearly 2.5%. Goldman Sachs dropped 2.5%.

Lenders typically feel the squeeze as recessions heighten concerns over credit losses due to higher unemployment. Loan demand - a key factor in profitability - also takes a beating.

"The economy is potentially slowing more than people appreciated, based on last week's economic data, that first and foremost is the biggest driver as it impacts loan growth, income growth, credit quality," said Jason Goldberg, banking analyst at Barclays.

Investors have been jittery since a crisis of confidence hit the sector last year, in part due to higher interest rates, and took down three major regional players.

Among regional banks, Customers Bancorp (NYSE:CUBI)'s shares fell nearly 4.4%, while Huntington Bancshares (NASDAQ:HBAN) dropped 3.4%.

"This market volatility, coupled with potential liquidity dislocation, could pose significant challenges for banks, especially in managing funding and liquidity risks," said Moody's (NYSE:MCO) Corp's banking analyst Laurent Birade.

The U.S. unemployment rate jumped to a near three-year high of 4.3% in July amid a significant slowdown in hiring, heightening fears the labor market was deteriorating and potentially making the economy vulnerable to a recession.

"It's very normal, especially with interest rates having gone up as much as they have and you're seeing that weakness in the commercial real estate market, to see credit losses normalizing," said Erika Najarian, analyst at UBS.

"The jobs print is essentially saying things are not as awesome as they were, they're not saying that things are terrible."

The economic weakness will likely seep into the sector's outlook after a mixed sector-quarter earnings season, where executives from top U.S. banks remained divided over the Fed's future path on interest rate cuts and flagged deterioration in consumer health.

"This may be a few-day blip. I don't think anybody's ready to call this the beginning of a several-quarter downturn in the markets or the economy," said Stephen Biggar, banking analyst at Argus Research.

Morgan Stanley analyst Manan Gosalia said in a note potential rate cuts will be credit positive for mid-sized banks as it will help reduce funding costs and stimulate loan demand.

The S&P 500 Banks Index is down 9.5% month-to-date, compared with a 6% decline in the benchmark S&P 500. The KBW Regional Banking Index has lost about 10% over the same period.