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China Banks, Italy Woes Trigger Asia Sell-Off

Asian markets were faced with a triple whammy on Thursday as shares sold-off on worries over China's fresh tightening measures, fears of a European bank run as Cypriot lenders gear up to reopen their branches and a political impasse in Rome.

The Shanghai Composite traded at its lowest levels in a week, the Nikkei lost 1.2 percent and the Hang Seng Index fell off Wednesday's two-week high. Seoul shares closed flat and the S&P ASX 200 ended at a session low of 4,966.

Risk appetite in Asia was also subdued ahead of a public holiday on Friday, which marks the end of the first quarter. The majority of global markets, including the U.S. and London, will be shut for the Good Friday holiday.

From January to March, Japan is Asia's best performer, up 19 percent compared to an 8 percent gain in London's FTSE and the Dow's 11 percent rise.

Markets were jolted by Rome's lack of progress in forming a new government, which sent the spread between 10-year Italian and German bond yields to their widest levels this year on Wednesday.

In response, the euro got hammered, extending losses below $1.28 against the greenback to its lowest levels since late November.

(Read More: Only an 'Insane Person' Would Want to Run Italy: Bersani)

Meanwhile, fears of a Europe-wide bank run continues to hurt sentiment. Cypriot authorities will enforce strict capital controls on local banks when they re-open for the first time in two weeks to prevent a massive outflow of funds.

"It's a Lehman moment psychologically. If you're not worried, you're not thinking clearly because the contagion that people are worried about are bank runs elsewhere in Europe," said Mike Crofton, president and CEO at Philadelphia Trust Company on CNBC's "Asia Squawk Box."

China Banks in Focus

Mainland-listed banks suffered steep losses after China's banking regulator unveiled new controls on wealth management products on Wednesday in order to reduce risk.

Industrial Bank nosedived 10 percent while China Minsheng Bank plunged 9 percent and Anxin Trust tumbled over 7 percent.

"While we feel this is clearly negative for the local banks; for other asset classes these measures represent a prudent and disciplined approach to what is clearly a growing problem for the Chinese," said Chris Weston of IG Markets in a research note.

Weakness in the mainland overshadowed positive earnings momentum in Hong Kong. The Hang Seng index lost 0.7 percent after closing at a two-week high in the previous session.

The world's biggest bank by market value, Industrial and Commercial Bank of China slipped as much as 1 percent despite posting a 14.5 percent rise in 2012 earnings.

Nikkei Dives 1.2%

Electronic exporters with high exposure to the euro zone weighed on the Nikkei. Sharp shares fell 3.6 percent while Sony lost 3 percent.

(Read More: Gains in Nikkei – You Ain't Seen Nothing Yet)

Investors held off on buying as they await the central bank's highly-anticipated policy meeting under the new leadership of Haruhiko Kuroda. Expectations of bold stimulus have driven the Nikkei up 18 percent since the start of 2013 and investors are counting on Kuroda to deliver his promise of open-ended asset purchases to reflate the economy and weaken the yen.

Shares of battery maker GS Yuasa plummeted over 11 percent after Mitsubishi Motors said one of their batteries overheated on their hybrid Outlander vehicles.

The Nikkei is about 2.5 percent below Thursday's four-and-a-half-year high of 12,650.

Kospi Treads Water

South Korea's stock index managed to close in positive territory after hovering near the 1,990 level for most of the session. The index closed 3 points shy from a two-week high of 1,996 points and is down 0.2 percent for the first quarter.

Investors sat on the sidelines as they awaited further details of a spending bill that could boost economic growth and drive stock market gains. South Korea's government promised fresh stimulus measures on Thursday, including an extra budget over the coming weeks.

Sydney Falls 0.6%

In Sydney, a 17 percent plunge in shares of Nufarm weighed on the index after the pesticide maker warned of losses for the fiscal year.

The Reserve Bank of Australia (RBA) holds a policy review next Tuesday and investors will be curious to see if the central bank will cut cash rates in a bid to insulate the economy from the ongoing euro zone instability. The RBA left the door open to further cuts at a meeting earlier this month.

(Read More: Are Aussie Stocks Headed for a Correction?)

One factor that plays in favor of more easing is a high Australian dollar after the currency hit a two-month high of $1.0445 on Tuesday.

The benchmark ended the first quarter up 7 percent but fell 2.7 percent for March.