Wall Street fell on Thursday, dragged down by financial stocks, after the European Central Bank tempered hopes that policymakers were readying a financial bazooka to contain the debt crisis.

In another development weighing on the market, European banks were told to increase their capital by 114.7 billion euros.

ECB President Mario Draghi discouraged expectations the central bank would massively step up buying of government bonds after a crucial Brussels summit on Friday.

His comments, coupled with a stark warning about the health of the region's economy, overshadowed a cut in the bloc's interest rate back to a record low 1 percent and extra liquidity provisions for banks.

We've been burnt by Europe and we don't really expect anything good. The market is very skeptical, said James Dailey, portfolio manager of TEAM Asset Strategy Fund in Harrisburg, Pennsylvania.

(But) The market was overbought to start off with, so a consolidation here is not that bad, especially in financial stocks.

The S&P financial sector index <.GSPF> was the biggest loser, falling nearly 3 percent. That followed sharp losses in European banks' shares as sources told Reuters the European Banking Authority (EBA) sees the capital shortfall at European banks at 114.7 billion euros ($154 billion).

Shares of Morgan Stanley , a barometer of risk aversion due to its perceived exposure to Europe's crisis, fell 6.8 percent to $16.16.

The Dow Jones industrial average <.DJI> was down 148.23 points, or 1.22 percent, at 12,048.14. The Standard & Poor's 500 Index <.SPX> was down 20.42 points, or 1.62 percent, at 1,240.59. The Nasdaq Composite Index <.IXIC> was down 37.14 points, or 1.40 percent, at 2,612.07.

The decline comes after three days of gains for U.S. stocks when the S&P 500 tried and failed to stay above its 200-day moving average, which has been a key level for investors to watch this year, and one that could prove tough to break.

But Thursday's pullback, concentrated in economically sensitive areas, was a far cry from the wild swings of recent months when uncertainty over Europe has dominated headlines. That is being seen as a sign of resilience by many investors who are hoping for seasonal strength into the end of the year.

France and Germany plan to use Friday's summit to lobby for their plan to amend the European Union treaty to toughen budget discipline, which they want to have ready by March. But several countries are skeptical.

The market really wants to wait until tomorrow to see what comes out of the summit, said Ken Polcari, a floor trader at NYSE with ICAP Equities. You are going to see the markets bounce around until tomorrow.

Yields on European sovereign debt spiked. Ten-year Italian government bond yields rose 44 basis points to 6.51 percent -- the day's high. German Bund futures hit a session high of 136.89, up 109 ticks on the day.

Losses were limited as U.S. jobless claims fell more than expected in the latest week, a sign the labor market recovery was gaining momentum. Claims fell to a nine-month low.

Boeing Co's biggest union ratified a contract extension late Wednesday, ensuring a new version of the aircraft maker's 737 narrow body plane will be built in Washington state and likely ending a dispute with the National Labor Relations Board. Shares of the Dow component slipped 0.3 percent to $70.37 after trading as high as $71.10 in the morning.

Costco Wholesale Corp fell 1.7 percent to $85.98 after reporting its first-quarter results.

McDonald's Corp shares rose 0.8 percent to $97.24 after the fast-food chain reported a bigger-than-expected rise in November sales at established restaurants across the board.

(Reporting By Angela Moon; Editing by Kenneth Barry)